| **U. S. SECURITIES AND EXCHANGE COMMISSION**                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **WASHINGTON, D.C. 20549**                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
| **FORM 10-Q**                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|  (X)                                                                                                                                                                                                                                                                                                                                                                                                                                                     | QUARTERLY REPORT PURSUANT  TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               | OF 1934 |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
| For the quarterly period ended March 31, 2008                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
| OR                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|  (  )                                                                                                                                                                                                                                                                                                                                                                                                                                                    | TRANSITION REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               | OF 1934 |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
| For the transition period from __________ to  __________                                                                                                                                                                                                                                                                                                                                                                                                           |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
| Commission file number  0-26016                                                                                                                                                                                                                                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
| **PALMETTO BANCSHARES, INC.**                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| (Exact name of registrant as specified in its  charter)                                                                                                                                                                                                                                                                                                                                                                                                            |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
| **South Carolina**                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | **74-2235055** |
| (State or other jurisdiction of incorporation or  organization)                                                                                                                                                                                                                                                                                                                                                                                                    |   | (IRS Employer Identification No.) |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   |
| **301 Hillcrest Drive, Laurens, South Carolina**                                                                                                                                                                                                                                                                                                                                                                                                                   |   | **29360** |
| (Address of principal executive offices)                                                                                                                                                                                                                                                                                                                                                                                                                           |   | (Zip Code) |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   | ** ** | ** ** | ** ** | ** ** |   |   | ** ** | ** ** | ** ** | ** ** |   |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   | ** ** | ** ** | ** ** | ** ** |   |   | ** ** | ** ** | ** ** | ** ** |   |
| **(864) 984–4551**                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (Registrant’s telephone number)                                                                                                                                                                                                                                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|           Indicate by check mark  whether the registrant (1) has filed all reports required to be filed by  Section  13 or 15(d) of the  Securities Exchange Act of 1934 during the preceding 12 months (or for such  shorter period that the registrant was  required to file such reports), and (2) has been subject to such filing  requirements  

for the past 90 days. Yes  X   No __  |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|           Indicate by check mark  whether the registrant is a large accelerated filer, an accelerated filer, or  a  non-accelerated filer.  See  definitions of "large accelerated filer," "accelerated  filer" and "smaller reporting company" in Rule 12b-2  of the Exchange Act.                                                                                           |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               | Large accelerated filer [ ] |   | Accelerated filer [x] |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               | Non-accelerated filer [ ] |   | Smaller reporting company  [  ] |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|           Indicate by check mark  whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  Yes [ ] No  [x]                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|           Indicate the number of  shares outstanding of each of the issuer's classes of common stock, as of the  latest practicable date.                                                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   | Class |   | Outstanding at May 9, 2008 |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |  ----------------------------- |   |   ------------------------------- |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   | Common stock, $5.00 par value |   | 6,432,990 |   |   |

 

 

 

 

----

 

 

 
| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY** |
|-----------------------------------------------|
| **Table of  Contents**                        |
|                                          |   |   |   |   |
|                                          |   |   | Page |   |
|                                          |   |   |   |   |
| PART I - FINANCIAL INFORMATION                |   |   |
|                                          | Item 1. | Financial Statements | 2 |   |
|                                          | Item 2. | Management's Discussion and Analysis of Financial  Condition and | 27 |   |
|                                          |   |      Results of Operations |   |   |
|                                          | Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 52 |   |
|                                          | Item 4. | Controls and Procedures | 52 |   |
|                                          |   |   |   |   |
| PART II - OTHER INFORMATION                   |   |   |
|                                          | Item 1. | Legal Proceedings | 53 |   |
|                                          | Item 1A. | Risk Factors | 53 |   |
|                                          | Item 2. | Unregistered Sales of Equity Securities and Use of  Proceeds | 53 |   |
|                                          | Item 3. | Defaults Upon Senior Securities | 53 |   |
|                                          | Item 4. | Submission of Matters to a Vote of Security Holders | 53 |   |
|                                          | Item 5. | Other Information | 53 |   |
|                                          | Item 6. | Exhibits | 53 |   |
|                                          |   |   |   |   |
| SIGNATURES                                    | 54 |   |
|                                          |   |   |   |   |
|                                          |   |   |   |   |

 

 

 

 

 

 

----

 

 

 

 

*Certain statements contained inthis Quarterly Report on Form 10-Q that are not statements of historicalfact constitute forward-looking statements within the meaning of theSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities and Exchange Act of 1934, as amended, notwithstanding that such statements are not specificallyidentified as such. In addition, certain statements may be contained in theregistrant’s future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and writtenstatements made by or with the approval of the registrant that are notstatements of historical fact and constitute forward-looking statements. Broadlyspeaking, forward-looking statements include, but are not limited to,projections of the registrant’s revenues, income, earnings per common share,capital expenditures, dividends, capital structure, or other financial items,descriptions of plans or objectives of management for future operations,products or services, forecasts of the registrant’s future economicperformance, and descriptions of assumptions underlying or relating to any ofthe foregoing.  Because these statements discuss future events or conditions,forward-looking statements often include words such as “anticipate,” “believe,”“estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,”“may,” “should,” “will,” “would,” “targeted,” “continue,” “remain,” or other similar expressions that are intended to identifyforward-looking statements but are not the exclusive means of identifying suchstatements.*

* *

*Forward-looking statementsinvolve risks and uncertainties that may cause actual results to differmaterially from those in such statements. Refer to the registrant’s AnnualReport on Form 10-K for the year ended December 31, 2007 for a discussion of thematerial risks and uncertainties that managementbelieves impact the registrant and may cause actual results to differ fromthose discussed in the forward-looking statements.*

* *

* *

*The registrant wishes to caution readers not to placeundue reliance on any forward-looking statements, which speak only as of thedate made. The registrant also wishes to advise readers that the factors listedabove could impact the registrant’s financial performance and could cause theregistrant’s actual results for future periods to differ materially from anyopinions or statements expressed with respect to future periods in any currentstatements. The registrant does not undertake, and specifically disclaims anyobligation, to publicly release the result of any revisions that may be made toany forward-looking statements to reflect events or circumstances after thedate of such statements or to reflect the occurrence of anticipated orunanticipated events.*

 

 

 

 

 

 

 

1

----

 

 

 

 

PART I – FINANCIALINFORMATION

** **

**ITEM 1.****FINANCIAL STATEMENTS**

* *

| **PALMETTO  BANCSHARES, INC. AND SUBSIDIARY**                          |
|------------------------------------------------------------------------|
| **Consolidated  Balance Sheets**                                       |
| **(dollars in thousands,  except common and per share data)**          |
|                                                                   |   |   |   |   |   |   |   |
| ** **                                                             |   |   |   |   | **March 31,** |   | **December 31,** |
|                                                                   |   |   |   |   | **2008** | ** ** | **2007** |
|                                                                   |   |   |   |   |  (unaudited) |   |   |
| Assets                                                                 |   |   |   |   |   |   |
| Cash and cash equivalents                                              |   |   |   |   |
|                                                                   | Cash and due from banks | $ | 32,972  |   |                   42,450  |
|                                                                   | Federal funds sold |   |                        974  |   |                     9,782  |
|                                                                   |   | Total cash and cash equivalents |                   33,946  |   |                   52,232  |
|                                                                   |   |   |   |   |   |   |   |
| Federal Home Loan Bank ("FHLB") stock, at cost               |                     4,788  |   |                     2,617  |
| Investment securities available for sale, at fair market  value        |                 127,150  |   |                   95,715  |
| Mortgage loans held for sale                                           |   |                   11,804  |   |                     5,006  |
|                                                                   |   |   |   |   |   |   |   |
| Loans                                                                  |   |   |   |              1,072,825  |   |              1,044,770  |
|                                                                   | Less: allowance for loan losses |   |                    (7,488) |   |                    (7,418) |
|                                                                   |   | Loans, net |   |              1,065,337  |   |              1,037,352  |
|                                                                   |   |   |   |   |   |   |   |
| Premises and equipment, net                                            |   |                   26,097  |   |                   25,133  |
| Goodwill                                                               |   |   |   |                     3,691  |   |                     3,691  |
| Core deposit intangibles                                               |   |                          68  |   |                          79  |
| Accrued interest receivable                                            |   |                     6,518  |   |                     6,655  |
| Other                                                                  |   |   |   |                   16,376  |   |                   19,697  |
|                                                                   |   |   | Total assets | $ | 1,295,775  |   |              1,248,177  |
|                                                                   |   |   |   |   |   |   |   |
| Liabilities and shareholders' equity                                   |   |   |   |   |
| Liabilities                                                            |   |   |   |   |   |   |
| Deposits                                                               |   |   |   |   |   |   |
|                                                                   | Noninterest-bearing | $ | 134,943  |   |                 135,111  |
|                                                                   | Interest-bearing |   |                 920,231  |   |                 923,683  |
|                                                                   |   | Total deposits |   |              1,055,174  |   |              1,058,794  |
|                                                                   |   |   |   |   |   |   |   |
| Retail repurchase agreements                                           |   |                   15,798  |   |                   11,280  |
| Commercial paper (Master notes)                                        |   |                   29,425  |   |                   26,326  |
| Other short-term borrowings                                            |   |                   37,500  |   |                   30,000  |
| Long-term borrowings                                                   |   |                   35,000  |   |                           -   |
| Accrued interest payable                                               |   |                     1,916  |   |                     2,042  |
| Other                                                                  |   |   |   |                     8,126  |   |                     9,479  |
|                                                                   |   | Total liabilities |   |              1,182,939  |   |              1,137,921  |
|                                                                   |   |   |   |   |   |   |   |
| Shareholders' equity                                                   |   |   |   |   |
| Common stock - par value $5.00 per share;  authorized  10,000,000 |   |   |   |
|                                                                   | shares; issued and outstanding 6,432,765 and 6,421,765 |   |   |   |
|                                                                   | at March 31, 2008 and December 31, 2007, respectively |                   32,164  |   |                   32,109  |
| Capital surplus                                                        |   |   |                     1,829  |   |                     1,664  |
| Retained earnings                                                      |   |                   81,481  |   |                   79,221  |
| Accumulated other comprehensive loss, net of tax                       |                    (2,638) |   |                    (2,738) |
|                                                                   |   | Total shareholders' equity |   |                 112,836  |   |                 110,256  |
|                                                                   |   |   |   |   |   |   |   |
|                                                                   |   |   | Total liabilities and shareholders' equity | $
1,295,775 

 

             1,248,177 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Consolidated  Interim Financial Statements

 

 

 

 

 

 

 

 

 

 

 

2

 

 

 

 

 

**PALMETTO  BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Interim  Statements of Income**

**(dollars in  thousands, except common and per share data)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three  month periods ended March 31,**

 

 

 

 

 

 

 

**2008**

** **

**2007**

 

 

 

 

 

 

 

(unaudited)

Interest income

 

 

 

 

 

 

 

 

Interest earned and fees on loans

$

19,051 

 

                                 18,766	

 

Interest earned on investment securities available for  sale:

 

 

 

 

 

Government-sponsored enterprises (taxable)

                                      199	

 

                                      435	

 

 

State and municipal (nontaxable)

 

                                      459	

 

                                      424	

 

 

Mortgage-backed (taxable)

 

                                      432	

 

                                      312	

 

Dividends paid on FHLB stock

 

                                        57	

 

                                        37	

 

Interest earned on federal funds sold 

 

                                        37	

 

                                      208	

 

Interest earned on cash and due from banks

                                          5	

 

                                        16	

 

 

 

Total interest income

 

                                 20,240	

 

                                 20,198	

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

Interest paid on deposits

 

 

                                   7,116	

 

                                   7,227	

 

Interest paid on retail repurchase agreements

                                      112	

 

                                      146	

 

Interest paid on commercial paper   

 

                                      144	

 

                                      238	

 

Interest paid on other short-term borrowings

                                      251	

 

                                        29	

 

Interest paid on long-term borrowings

 

                                        68	

 

                                        95	

 

 

 

Total interest expense

 

                                   7,691	

 

                                   7,735	

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

                                 12,549	

 

                                 12,463	

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

                                      488	

 

                                      367	

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

                                 12,061	

 

                                 12,096	

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

Service charges on deposit accounts

 

                                   2,167	

 

                                   1,908	

 

Fees for trust and investment management and brokerage  services

                                      756	

 

                                      696	

 

Mortgage-banking income

 

 

                                      253	

 

                                      348	

 

Other 

 

 

 

 

                                   1,513	

 

                                      947	

 

 

 

Total noninterest income

 

                                   4,689	

 

                                   3,899	

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

Salaries and other personnel 

 

 

                                   6,195	

 

                                   6,137	

 

Occupancy

 

 

 

                                      421	

 

                                      370	

 

Furniture and equipment

 

 

                                   1,328	

 

                                   1,277	

 

Marketing 

 

 

 

                                      332	

 

                                      268	

 

Amortization of core deposit intangibles

 

                                        11	

 

                                        12	

 

Other 

 

 

 

 

                                   2,880	

 

                                   2,145	

 

 

 

Total noninterest expense

 

                                 11,167	

 

                                 10,209	

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

                                   5,583	

 

                                   5,786	

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

 

                                   1,937	

 

                                   2,025	

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

3,646 

 

                                   3,761	

 

 

 

 

 

 

 

 

 

 

Common share data

 

 

 

 

 

 

Net income  - basic

$

0.57 

 

                                     0.59	

 

Net income - diluted

 

                                     0.56	

 

                                     0.58	

 

Cash dividends 

 

                                     0.20	

 

                                     0.19	

 

Book value 

 

                                   17.54	

 

                                   16.17	

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic

                            6,431,172	

 

                            6,378,516	

 

Weighted average common shares outstanding - diluted

                            6,519,127	

 

                            6,455,805	

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to  Consolidated Interim Financial Statements.

 

 

 

 

 

 

 

 

 

 

 

 

3

 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

** Consolidated Interim  Statements of Changes in Shareholders' Equity and Comprehensive Income**

**(dollars in  thousands, except common and per share data) (unaudited)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

** **

** **

** **

** **

** **

** **

** **

** **

**Accumulated**

** **

** **

 

 

**Shares of**

** **

** **

** **

** **

** **

** **

** **

**other**

** **

** **

 

 

**common**

** **

**Common**

** **

**Capital**

** **

**Retained**

** **

**comprehensive**

** **

** **

 

 

**stock**

** **

**stock**

** **

**surplus**

** **

**earnings**

** **

**income (loss),  net**

** **

**Total**

Balance at December 31, 2006

 

          6,367,450	

$

31,837 

$

1,102 

$

68,132 

$

(695)

$

       100,376 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

             3,761	

 

 

 

             3,761	

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Investment securities available for sale

 

 

 

 

 

 

 

 

 

 

 

          Change in unrealized position during the period,  net

 

 

 

 

 

 

 

 

 

 

 

               of tax impact of $20

 

 

 

 

 

 

 

 

 

32 

 

 

          Reclassification adjustment included

 

 

 

 

 

 

 

 

 

 

 

               in net income, net of tax impact of $0

 

 

 

 

 

 

 

 

                                    -  	

 

 

          Net unrealized gains on investment securities  available for sale

 

 

 

 

 

 

 

 

 

 

32 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

3,793 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividend declared and paid ($0.19 per share)

 

 

 

 

 

 

(1,213)

 

 

 

(1,213)

Compensation expense related to stock options

 

 

 

 

33 

 

 

 

 

 

33 

Stock option activity

 

               14,510	

 

               73	

 

                     113	

 

 

 

 

 

186 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2007

 

          6,381,960	

$

31,910 

$

1,248 

$

70,680 

$

(663)

$

       103,175 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2007

 

          6,421,765	

$

32,109 

$

1,664 

$

79,221 

$

(2,738)

$

       110,256 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

             3,646	

 

 

 

             3,646	

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Investment securities available for sale

 

 

 

 

 

 

 

 

 

 

 

          Change in unrealized position during the period,  net

 

 

 

 

 

 

 

 

 

 

 

               of tax impact of $274

 

 

 

 

 

 

 

 

 

445 

 

445 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Defined benefit pension plan

 

 

 

 

 

 

 

 

 

 

 

 

          Change in unrealized position during the period,  net

 

 

 

 

 

 

 

 

 

 

 

               of tax impact of $186

 

 

 

 

 

 

 

 

 

(345)

 

(345)

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

3,746 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative effect of adoption of new accounting standard  EITF 06-10

 

 

 

 

 

 

(99)

 

 

 

(99)

Cash dividend declared and paid ($0.20 per share)

 

 

 

 

 

 

(1,287)

 

 

 

(1,287)

Compensation expense related to stock options

 

 

 

 

                       23	

 

 

 

 

 

23 

Excess tax benefit from stock-based awards

 

 

 

 

                       78	

 

 

 

 

 

78 

Stock option activity

 

               11,000	

 

               55	

 

                       64	

 

 

 

 

 

119 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2008

 

          6,432,765	

$

32,164 

$

1,829 

 $

81,481 

$

(2,638)

$

       112,836 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to  Consolidated Interim Financial Statements

 

 

 

 

 

 

 

 

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Interim Statements of Cash Flows**

**(in thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month periods ended March 31,**

 

 

 

 

 

 

**2008**

 

**2007**

 

 

 

 

 

 

(unaudited)

Operating Activities

 

 

 

 

 

 

Net income

 

 

$

3,646 

 

3,761 

 

Adjustments to reconcile net income to net cash (used in) provided by operating activities

 

 

 

 

 

Premises, furniture, and equipment depreciation

482 

 

506 

 

 

Amortization of core deposit intangibles

11 

 

12 

 

 

Amortization of unearned discounts / premiums on investment securities available for sale, net

10 

 

21 

 

 

Amortization of unearned discounts / premiums on mortgage-backed securities, net

58 

 

12 

 

 

Provision for loan losses

488 

 

367 

 

 

Originations of mortgage loans held for sale

(19,107)

 

(15,513)

 

 

Proceeds from sales of mortgage loans held for sale

13,105 

 

13,155 

 

 

Gains on sales of mortgage loans held for sale, net

(796)

 

(178)

 

 

Writedowns and losses on sales of real estate acquired in settlement of loans

70 

 

166 

 

 

Compensation expense related to stock options granted

23 

 

33 

 

 

Excess tax benefit from stock-based awards

78 

 

- 

 

 

Decrease in accrued interest receivable and other assets, net

1,834 

 

700 

 

 

Increase (decrease) in accrued interest payable and other liabilities, net

(356)

 

656 

 

 

 

Net cash (used in) provided by operating activities

(454)

 

3,698 

 

 

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

 

Proceeds from maturities and calls of investment securities available for sale

12,430 

 

14,295 

 

Purchases of investment securities available for sale

- 

 

(5,659)

 

Purchases of mortgage-backed investment securities available for sale

(44,615)

 

- 

 

Repayments on mortgage-backed investment securities available for sale

1,401 

 

878 

 

Purchases of FHLB stock

(2,576)

 

- 

 

Redemptions of FHLB stock

405 

 

72 

 

Increase in loans, net

 

(28,865)

 

(9,243)

 

Proceeds on sales of real estate acquired in settlement of loans

105 

 

1 

 

Purchases of premises and equipment, net

(1,446)

 

(1,014)

 

 

 

Net cash used in investing activities

(63,161)

 

(670)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

 

Increase in transaction, money market, and savings deposit accounts, net

2,567 

 

35,187 

 

Decrease in time deposit accounts, net

(6,187)

 

(11,066)

 

Increase (decrease) in retail repurchase agreements, net

4,518 

 

(4,522)

 

Increase in commercial paper, net

3,099 

 

3,287 

 

Increase (decrease) in other short-term borrowings

7,500 

 

(6,000)

 

Proceeds from long-term borrowings

35,000 

 

- 

 

Proceeds from stock option activity

119 

 

186 

 

Cash dividends declared and paid on common stock

(1,287)

 

(1,213)

 

 

 

Net cash provided by financing activities

45,329 

 

15,859 

 

 

 

 

 

 

 

 

 

Net (decrease) increase of cash and cash equivalents

(18,286)

 

18,887 

Cash and cash equivalents, beginning of the period

52,232 

 

46,666 

Cash and cash equivalents, end of the period

$

33,946 

 

65,553 

 

 

 

 

 

 

 

 

 

Supplemental Cash Flow Disclosures

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest expense

 

$

7,817 

 

7,768 

 

 

Income taxes

 

2,212 

 

8 

 

Significant noncash investing and financing activities

 

 

 

 

 

Net unrealized gains on investment securities available for sale, net of tax

$

445 

 

32 

 

 

Net unrealized losses on defined benefit pension plan, net of tax

(345)

 

- 

 

 

Loans transferred to real estate acquired in settlement of loans, at fair market value

392 

 

501 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Consolidated Interim Financial Statements

 

 

 

 

 

 

 

 

 

** **

5

 

 

 

 

 

 

**PALMETTOBANCSHARES, INC. AND SUBSIDIARY**

**Notes ToConsolidated Interim Financial Statements**

** **

***1.       Summaryof Significant Accounting Policies***

 

*Natureof Operations*

* *

“Palmetto Bancshares” is a regional financial services bank holding companyorganized in 1982 under the laws of South Carolina and headquartered in Laurens,South Carolina that provides, through its subsidiary, a broad array ofcommercial banking, consumer banking, trust and investment management, andbrokerage services throughout its market area primarily within northwest SouthCarolina (the "Upstate").

* *

 

 

*Principles of Consolidation / Basis ofPresentation   *

*** ***

The accompanying ConsolidatedInterim Financial Statements include the accounts of Palmetto Bancshares, Inc.,the “Company”, which includes its wholly owned subsidiary, the “Bank”, andthe Bank's wholly owned subsidiary, “Palmetto Capital.”  In management’sopinion, all significant intercompany accounts and transactions have beeneliminated in consolidation. The accounting and financial reporting policies theCompany follows conform, inall material respects, to accounting principles generally accepted in theUnited States and to general practices within the financial services industry.

 

The Consolidated InterimFinancial Statements in this Quarterly Report on Form 10-Q have not beenaudited by the Company’s independent registered public accounting firm, but inthe opinion of management, reflect all adjustments necessary for a fair presentationof the Company’s financial position and results of operations. All suchadjustments were of a normal and recurring nature. The Consolidated Interim Financial Statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and with the instructions to Form 10-Qadopted by the SEC. Accordingly, the ConsolidatedInterim Financial Statements do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements and should be read in conjunction withthe Company’s Consolidated FinancialStatements, and notes thereto, for the year ended December 31,2007, included in the Company’s Annual Report on Form 10-K. Operating resultsfor the interim periods disclosed herein are not necessarily indicative of theresults that may be expected for a full year or any future period.

 

*Use of Estimates*

* *

In preparing its ConsolidatedInterim Financial Statements, the Company’s management makes estimates andassumptions that impact the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities as of the date of the ConsolidatedInterim Financial Statements for the years presented. Actual resultscould differ from these estimates and assumptions. As such, the results ofoperations for the quarter ended March 31, 2008 are not necessarily indicativeof the results of operations that may be expected in future periods.

 

Business Segments

 

The Company adheres to the provisions of the FinancialAccounting Standards Board’s (“FASB”) Statement of Financial AccountingStandards (“SFAS”) No. 131, "Disclosures About Segments of an Enterpriseand Related Information." Operating segments are components of anenterprise about which separate financial information is available that areevaluated regularly by the chief operating decision makers in deciding how toallocate resources and assess performance. SFAS No. 131 requires that a publicenterprise report a measure of segment profit or loss, certain specific revenueand expense items, segment assets, and information about the way that theoperating segments were determined, among other items. 

 

TheCompany considers business segments by analyzing distinguishable components that are engaged in providing individualproducts, services or groups of related products or services and that aresubject to risks and returns that are different from those of other businesssegments. To this end, when determining whether products and services arerelated, the Company considers the nature of the products or services, thenature of the production processes, the type or class of customer for which theproducts or services are designed, and the methods used to distribute theproducts or provide the services. 

 

6

 

 

 

 

 

AtMarch 31, 2008, the Company had made no changes to its determination in itsAnnual Report on Form 10-K for the year ended December 31, 2007 that it had onereportable operating segment, banking.  As such, separate segment informationis not presented within this Quarterly Report on Form 10-Q as managementbelieves that the Company’s Consolidated Interim Financial Statements report the information required by SFAS No. 131 withregard to the Company’s operating segment, banking.

 

Reclassifications

* *

Certain amounts previously presented in the Company’s Consolidated Interim Financial Statements forprior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on the prior years’ net income orretained earnings as previously reported. 

 

The following tablesummarizes the Company’s Consolidated Interim Balance Sheet at December31, 2007, as then reported, prior to these reclassifications (in thousands).

 

 

 

 

 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Balance Sheet**

**(dollars in thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31,**

 

 

 

 

 

 

**2007**

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

Cash and due from banks

 

 

$

41,769 

 

Federal funds sold

 

 

10,463 

 

 

Total cash and cash equivalents

 

52,232 

 

 

 

 

 

 

 

FHLB stock, at cost

 

 

2,617 

Investment securities available for sale, at fair market value

95,715 

Mortgage loans held for sale

 

 

5,006 

 

 

 

 

 

 

 

Loans

 

 

 

 

1,044,770 

 

Less: allowance for loan losses

 

(7,418)

 

 

Loans, net

 

 

1,037,352 

 

 

 

 

 

 

 

Premises and equipment, net

 

 

25,133 

Goodwill

 

 

 

 

3,691 

Core deposit intangibles

 

 

79 

Accrued interest receivable

 

 

6,655 

Other

 

 

 

 

19,697 

 

 

 

Total assets

 

 

$

1,248,177 

 

 

 

 

 

 

 

Liabilities and shareholders' equity

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

 

Noninterest-bearing

 

 

$

135,111 

 

Interest-bearing

 

 

923,683 

 

 

Total deposits

 

 

1,058,794 

 

 

 

 

 

 

 

Retail repurchase agreements

 

 

11,280 

Commercial paper (Master notes)

 

26,326 

Federal funds purchased

 

 

30,000 

FHLB borrowings - long-term

 

 

- 

Accrued interest payable

 

 

2,042 

Other

 

 

 

 

9,479 

 

 

Total liabilities

 

 

1,137,921 

 

 

 

 

 

 

 

Shareholders' equity

 

 

 

Common stock

 

 

32,109 

Capital surplus

 

 

1,664 

Retained earnings

 

 

79,221 

Accumulated other comprehensive loss, net of tax

 

(2,738)

 

 

Total shareholders' equity

 

110,256 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,248,177 

 

 

 

 

 

 

 

 

Cash and cash equivalents arecomprised of cash and due from banks as well as federal funds sold tocorrespondent banks.  Federal funds sold are essentially uncollateralized loansto other financial institutions. During 2007, interest-bearing cashbalances held at the FHLB were reported within the Federal Funds Sold financialstatement line item within the Consolidated Interim Balance Sheets.  During thefirst quarter of 2008, management concluded that, although such balances wereinterest-bearing, they were not federal funds sold.  As such, within thisQuarterly Report on Form 10-Q for the three month period ended March 31, 2008,such balances have been reclassified, resulting in prior periodreclassifications, and are reported within the Cash and Due From Banksfinancial statement line item within the Consolidated Interim Balance Sheets. 

 

The tableon the following pagesummarizes the Company’s Consolidated Interim Statements of Income forthe three month period ended March 31, 2007, as then reported, prior to thesereclassifications (in thousands).

 

 

7

 

 

 

 

 

 

 

 

 

 

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

**Consolidated Interim Statement of Income**

**(dollars in thousands, except common and per share data)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three**

**month period**

**ended March**

**31, 2007**

 

 

 

 

 

 

 

Interest income

 

 

 

 

Interest and fees on loans

 

$

18,766 

 

Interest on investment securities available for sale

1,171 

 

Interest on federal funds sold

 

224 

 

Dividends on FHLB stock

 

37 

 

 

 

Total interest income

 

20,198 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

Interest on deposits

 

7,227 

 

Interest on retail repurchase agreements

146 

 

Interest on commercial paper

 

238 

 

Interest on federal funds purchased

29 

 

Interest on FHLB borrowings - short-term

- 

 

Interest on FHLB borrowings - long-term

95 

 

 

 

Total interest expense

 

7,735 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

12,463 

 

 

 

 

 

 

 

Provision for loan losses

 

367 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

12,096 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

Service charges on deposit accounts

1,908 

 

Fees for trust and brokerage services

696 

 

Mortgage-banking income

 

348 

 

Investment securities gains

 

- 

 

Other

 

 

 

880 

 

 

 

Total noninterest income

3,832 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

Salaries and other personnel

 

6,137 

 

Occupancy

 

 

370 

 

Furniture and equipment

 

481 

 

Premises and equipment leases and rentals

290 

 

Premises and equipment depreciation

506 

 

Marketing

 

 

268 

 

Amortization of core deposit intangibles

12 

 

Other

 

 

 

2,078 

 

 

 

Total noninterest expense

10,142 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

5,786 

 

 

 

 

 

 

 

Provision for income taxes

 

2,025 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

3,761 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consistent with the reclassification of interest-bearingcash balances held at the FHLB from federal funds sold within the ConsolidatedInterim Balance Sheets, interest income from such accounts was also segregatedfrom interest earned on federal funds sold on the Consolidated InterimStatements of Income. 

 

Within this Quarterly Report on Form 10-Q for the threemonth period ended March 31, 2008, interest expense on federal funds purchasedand interest expense on FHLB borrowings – short term previously reportedseparately on the Consolidated Interim Statements of Income have beenaggregated and are being reported within the Interest in Other Short-TermBorrowings financial statement line item on the Consolidated Interim Statementsof Income.  

 

8

 

 

During 2007, in an effort to provide more transparent information to readers offinancial statements, the Company reclassified certain expenses relating to theoperation of its automatic teller machines, the Company’s operation of itsInternet banking product, and the Company’soffering of merchant and cardholder services.  During the three month periodended March 31, 2007, such amounts were reported net of related income withinthe Other Noninterest Income financial statement line item within theConsolidated Interim Statements of Income.  Within this Quarterly Report onForm 10-Q for the three month period ended March 31, 2008, such expenses havebeen reclassified, resulting in prior period reclassifications, and arereported gross within the Other Noninterest Expense financial statement lineitem within the Consolidated Interim Statements of Income. 

 

Within this Quarterly Report on Form 10-Q for the threemonth period ended March 31, 2008, premises, furniture, and equipment balancesthat were previously reported separately within Consolidated Interim Statementsof Income were segregated due to such desegregated balances not meetingmateriality thresholds determined using total interest income and other incomebalances.  Management does not believe such separately reported balancesresulted in more transparent information to readers of financial statements.

 

Within this Quarterly Reporton Form 10-Q for the three month period ended March 31, 2008, in an effort toprovide more detailed information to the readers of the Company’s ConsolidatedInterim Financial Statements, financial statement line items previously reportedin the Company’s Consolidated Interim Statement of Cash Flows for the threemonth period ended March 31, 2007 were further broken down in order to complywith current classifications.  The following table summarizes the reporting ofsuch items in the Company’s Quarterly Report on Form 10-Q for the three monthperiod ended March 31, 2007 (in thousands).

 

 

**For the three month**

**period ended March 31, **

Depreciation, amortization, and accretion, net

$

551 

 

 

Maturities, redemption, calls, and principal repayments of investment securities available for sale

15,173 

 

 

Deposits, net

24,121 

 

 

 

The following tablesummarizes the reporting of such items in the Company’s Quarterly Report onForm 10-Q for the three month period ended March 31, 2008 (in thousands).

 

 

 

 

 

**For the three month**

**period ended March 31, **

Premises, furniture, and equipment depreciation

$

506 

Amortization of core deposit intangibles

12 

Amortization of unearned discounts / premiums on investment securities available for sale, net

21 

Amortization of unearned discounts / premiums on mortgage-backed securities, net

12 

 

551 

 

 

Proceeds from maturities and calls of investment securities available for sale

14,295 

Repayments on mortgage-backed investment securities available for sale

878 

 

15,173 

 

 

Increase in transaction, money market, and savings deposit accounts, net

35,187 

Decrease in time deposit accounts, net

(11,066)

 

24,121 

 

 

 

*Recently Issued / Adopted Accounting Pronouncements*

 

 

 

In September 2006, the FASB issuedSFAS No. 157, "Fair Value Measurements,” which provides guidance for usingfair value to measure assets and liabilities but does not expand the use offair value in any circumstance. SFAS No. 157 also requires expanded disclosuresabout the extent to which a company measures assets and liabilities at fairvalue, the information used to measure fair value, and the effect of fair valuemeasurements on an entity’s financial statements. The statement applies whenother standards require or permit assets and liabilities to be measured at fairvalue. SFAS No. 157 was effective for the Company forfiscal and interim periods beginning January 1, 2008.  Subsequently,in February 2008, the FASB issued FASB Staff Position (“FSP”) No. 157-2,“Effective Date of FASB Statement No. 157,” which delayed the effectivedate of SFAS No. 157 for nonrecurring, nonfinancial instruments to fiscal yearsbeginning after November 15, 2008. The Company adopted SFAS No. 157 onJanuary 1, 2008.  Its adoption did not have a material impact on theCompany’s financial position, results of operations or cash flows.  

 

In February 2007, the FASB issuedSFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities — Including an amendment of FASB StatementNo. 115.” SFAS No. 159 permits entities to choose to measure eligibleitems at fair value at specified election dates. Unrealized gains and losses onitems for which the fair value option has been elected are reported in earningsat each subsequent reporting date. The fair value option may be appliedinstrument by instrument, with certain exceptions, is irrevocable (unless a newelection date occurs), and is applied only to entire instruments and notto portions of instruments. SFAS No. 159 was effective for the Company onJanuary 1, 2008. SFAS No. 159 was effective for the Company on January 1,2008. The Company has not elected the fair value option for any financialassets or liabilities at March 31, 2008. As such, its adoptions did not have amaterial impact on the Company’s financial position, results of operations orcash flows. 

 

In March 2007, the FASB ratified the consensus reached by the Emerging IssuesTask Force (“EITF”) in Issue No. 06-10, “Accounting for Collateral AssignmentSplit-Dollar Life Insurance Arrangements.”  The EITF’s consensus concluded thatan employer should recognize a liability for the postretirement benefit relatedto a collateral assignment split-dollar life insurance arrangement inaccordance with either SFAS No. 106 (if, in substance, a postretirement benefitplan exists) or Accounting Principles Board (“APB”) Opinion No. 12, “OmnibusOpinion—1967,” (if the arrangement is, in substance, an individual deferredcompensation contract) if the employer has agreed to maintain a life insurancepolicy during the employee's retirement or provide the employee with a deathbenefit based on the substantive agreement with the employee. Additionally, theEITF concluded that an employer should recognize and measure an asset based onthe nature and substance of the collateral assignment split-dollar lifeinsurance arrangement. The EITF observed that in determining the nature andsubstance of the arrangement, the employer should assess what future cash flowsthe employer is entitled to, if any, as well as the employee'sobligation and ability to repay the employer. The consensus in this Issue iseffective for fiscal years beginning after December 15, 2007, including interimperiods within those fiscal years with earlier application permitted. Theconsensus further directs entities to recognize the effects of applying theconsensus in this Issue through either (a) a change in accounting principle througha cumulative-effect adjustment to retained earnings or to other components ofequity or net assets in the statement of financial position as of the beginningof the year of adoption or (b) a change in accounting principle throughretrospective application to all prior periods. The Company adopted EITF No.06-10 on January 1, 2008 as a change in accounting principle through acumulative-effect adjustment to retained earnings totaling $99 thousand.

 

In November 2007, the SEC issuedStaff Accounting Bulletin (“SAB”) No. 109, “Written Loan CommitmentsRecorded at Fair Value Through Earnings,” which expressed the views of thestaff regarding written loan commitments that are accounted for at fair valuethrough earnings under generally accepted accounting principles. SAB No. 105, “Applicationof Accounting Principles to Loan Commitments,” provided the views of the staffregarding derivative loan commitments that are accounted for at fair valuethrough earnings pursuant to SFAS No. 133. SAB No. 105 stated that in measuringthe fair value of a derivative loan commitment, the staff believed it would beinappropriate to incorporate the expected net future cash flows related to theassociated servicing of the loan. This SAB supersedes SAB No. 105 and expressesthe current view of the staff that, consistent with the guidance in SFAS No.156 and SFAS No. 159*,* the expected net future cash flows related to theassociated servicing of the loan should be included in the measurement of allwritten loan commitments that are accounted for at fair value through earnings.SAB No. 105 also indicated that the staff believed that internally-developedintangible assets (such as customer relationship intangible assets) should notbe recorded as part of the fair value of a derivative loan commitment. This SABretains that staff view and broadens its application to all written loancommitments that are accounted for at fair value through earnings. The staffexpects registrants to apply the views in SAB No. 109 on a prospective basis toderivative loan commitments issued or modified in fiscal quarters beginningafter December 15, 2007. The guidance within SAB No. 109 was effective onJanuary 1, 2008.  Its application did not have a material impact on theCompany’s financial position, results of operations or cash flows.  

 

9

 

In December 2007, the FASBissued SFAS No. 160, “Noncontrolling Interest in ConsolidatedFinancial Statements, an amendment of ARB StatementNo. 51.”**SFAS No. 160 amends Accounting Research Bulletin(“ARB”) No. 51, “Consolidated Financial Statements,” to establishaccounting and reporting standards for the noncontrolling interest in asubsidiary and for the deconsolidation of a subsidiary. SFAS No. 160clarifies that a noncontrolling interest in a subsidiary, which is sometimesreferred to as a minority interest, is an ownership interest in theconsolidated entity that should be reported as a component of equity in theconsolidated financial statements. Among other requirements, SFAS No. 160requires consolidated net income to be reported at amounts that include theamounts attributable to both the parent and the noncontrolling interest. Italso requires disclosure of the amounts of consolidated net income attributableto the parent and to the noncontrolling interest. SFAS No. 160 iseffective for the Company on January 1, 2009. The Company iscurrently evaluating the impact that the adoption of SFAS No. 160 will have onits financial position, results of operations, and cash flows.  

 

InDecember 2007, the FASB issued SFAS No. 141, “BusinessCombinations (Revised 2007).”**SFAS No. 141R replaces SFAS No. 141,“Business Combinations,” and applies to all transactions and other events inwhich one entity obtains control over one or more other businesses.SFAS No. 141R requires an acquirer, upon initially obtaining control ofanother entity, to recognize the assets, liabilities and any noncontrollinginterest in the acquiree at fair value as of the acquisition date. Contingentconsideration is required to be recognized and measured at fair value on thedate of acquisition rather than at a later date when the amount of thatconsideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost allocation process requiredunder SFAS No. 141 whereby the cost of an acquisition was allocated to theindividual assets acquired and liabilities assumed based on their estimatedfair value. SFAS No. 141R requires acquirers to expense acquisitionrelated costs as incurred rather than allocating such costs to the assetsacquired and liabilities assumed, as was previously the case under SFASNo. 141. Under SFAS No. 141R, the requirements of SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities,” would haveto be met in order to accrue for a restructuring plan in purchase accounting.Preacquisition contingencies are to be recognized at fair value, unless it is anoncontractual contingency that is not likely to materialize, in which case,nothing should be recognized in purchase accounting and, instead, thatcontingency would be subject to the probable and estimable recognition criteriaof SFAS No. 5, “Accounting for Contingencies.” SFAS No. 141R is effective for the Company onJanuary 1, 2009. The Company does believe that the adoption of SFASNo. 141R will have an impact on the Company’saccounting for business combinations, when and if applicable, and, as a result,may have a material impact on its financial position, results ofoperations and cash flows.  

 

In February 2008, the FASBissued FSP No. 140-3, “Accounting for Transfers of Financial Assets andRepurchase Financing Transactions.”  FSP No. 140-3 provides guidance onaccounting for a transfer of a financial asset and the transferor’s repurchasefinancing of the asset and presumes that an initial transfer of a financialasset and a repurchase financing are considered part of the same arrangement(linked transaction) under SFAS No. 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities-a replacementof FASB Statement No. 125.” However, if certain criteria are met, the initialtransfer and repurchase financing are not evaluated as a linked transaction andare evaluated separately under SFAS No.  140.  FSP No. 140-3 is effective for the Company for fiscal and interim periods beginningJanuary 1, 2009. Earlier application is not permitted. The Companyis currently evaluating the impact that the adoption of FSP No. 140-3 will haveon its financial position, results of operations, and cash flows.  

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about DerivativeInstruments and Hedging Activities-an amendment of FASB Statement No. 133,”which requires enhanced disclosures about an entity’s derivative and hedgingactivities and thereby improves the transparency of financial reporting. ThisSFAS No. 161 is effective for the Company on January 1, 2009, with earlyapplication encouraged. This Statement encourages, but does not require,comparative disclosures for earlier periods at initial adoption. The Company iscurrently evaluating the impact that the adoption of SFAS No. 161 will have onits financial position, results of operations, and cash flows.  

 

 

InApril 2008, the FASB issued FSP No. 142-3, “Determination of the Useful Life ofIntangible Assets.”  FSP No. 142-3 amends the factors that should be consideredin developing renewal or extension assumptions used to determine the usefullife of a recognized intangible asset under SFAS No. 142, “Goodwill and OtherIntangible Assets.”  This FSP is intended to improve the consistency betweenthe useful life of a recognized intangible asset under SFAS No. 142 and theperiod of expected cash flows used to measure the fair value of the asset underSFAS No. 141R**and other U.S. generally accepted accounting principles. FSP No. 142-3 is effective for the Company for fiscal and interim periodsbeginning January 1, 2009. Earlier application is not permitted. The Companyis currently evaluating the impact that the adoption of FSP No. 142-3 will haveon its financial position, results of operations, and cash flows.  

 

 

 

10

 

 

***2.      Cash and CashEquivalents***

 

The following tablesummarizes the composition of cash and due from banks at the datesindicated (in thousands).

 

 

 

**March 31,**

**December 31,**

 

 

**2008**

**2007**

Cash working funds

$

10,125 

11,122 

Interest-earning demand deposits in

other banks

43 

681 

Noninterest-earning demand deposits

in other banks

17,133 

20,883 

In-transit funds

5,671 

9,764 

 

Total cash and cash equivalents

$

32,972 

42,450 

 

 

 

 

 

The Federal Reserve Act requireseach depository institution to maintain reserves against its reservableliabilities as prescribed by Federal Reserve Board regulations. TheBank reports its reservable liabilities to the Federal Reserve on a weeklybasis.  Weekly reporting institutions maintain reserves on their reservableliabilities with a 30-day lag.  For the maintenance period ending on March 26,2008, based on reservable liabilities from February 12, 2008 through February25, 2008, the Federal Reserve required the Bank to maintain reserves of $9.4million.  Due to the Company’s levels of vault cash, no reserves were requiredto be maintained with correspondent banks, however; $1.0 million was requiredto be maintained with the Federal Reserve. Depositswith the Federal Reserve do not earn interest. 

* *

***3.       InvestmentSecurities Available for Sale***

 

During the first quarter of 2008, the Company beganinvesting in collateralized mortgage obligations. Collateralized mortgageobligations are a mortgage-backed security sub-type in which the mortgages areordered into tranches by some quality (such as repayment time), with eachtranche sold as a separate security. These securities, in addition to theCompany’s other investment securities available for sale, are accounted for inaccordance with SFAS No. 115, Accounting for Certain Investments in Debt andEquity Securities,” as discussed in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

The following tablessummarize the amortized cost, gross unrealized gains, gross unrealizedlosses, and fair market values of investment securities available for sale atthe dates indicated (in thousands).

 

 

 

 

 

**March 31, 2008**

 

 

 

 

**Amortized**

**cost**

**Gross**

**unrealized**

**gains**

**Gross**

**unrealized**

**losses**

**Fair**

**market**

**value**

 

 

 

 

 

 

 

 

Government-sponsored enterprises

$

8,746 

22 

- 

8,768 

 

State and municipal

52,161 

238 

(232)

52,167 

 

Collateralized mortgage obligation

44,622 

2 

(9)

44,615 

 

Other mortgage-backed

21,311 

308 

(19)

21,600 

 

 

Total investment securities

available for sale

$

126,840 

570 

(260)

127,150 

 

 

 

 

 

 

 

 

 

 

**December 31, 2007**

 

 

 

**Amortized**

**cost**

**Gross**

**unrealized**

**gains**

**Gross**

**unrealized**

**losses**

**Fair**

**market**

**value**

 

 

 

 

 

 

 

 

Government-sponsored enterprises

$

20,725 

26 

(8)

20,743 

 

State and municipal

52,677 

55 

(573)

52,159 

 

Other mortgage-backed

22,722 

196 

(105)

22,813 

 

 

Total investment securities

available for sale

$

96,124 

277 

(686)

95,715 

 

 

 

 

 

 

 

 

11

 

 

Approximately 58% of the investment securities portfolio waspledged to secure public deposits and trust assets as of March 31, 2008 ascompared with 80% at December 31, 2007.  Of the Company’s $127.2 millionavailable for sale investment securities balance at March 31, 2008, $53.3million was unpledged and, therefore, available as a liquidity source. Of theCompany’s $95.7 million available for sale investment securities balance atDecember 31, 2007, $19.1 million was unpledged and, therefore, available as aliquidity source. The decrease in pledged securities as a percentage of theinvestment securities portfolio from December 31, 2007 to March 31, 2008 wasthe result of an increase in the investment security portfolio.  Investmentsecurities pledged to secure public deposits and trust assets at of March 31,2008 totaled $73.9 million relatively unchanged from $76.6 million at December31, 2007.

 

*Impairment Analysis*

* *

The following tables summarize the gross unrealized losses,fair market value, and the number of securities in each category of investmentsecurities available for sale, aggregated by investment category and length oftime that individual securities have been in a continuous unrealized lossposition, at March 31, 2008 and December 31, 2007 (dollars in thousands).

 

 

 

**March 31, 2008**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

Government-sponsored enterprises

- 

$

- 

$

- 

 

- 

- 

- 

 

- 

- 

- 

State and municipal

48 

19,770 

137 

 

15 

5,934 

95 

 

63 

25,704 

232 

Collateralized mortgage obligation

9 

41,043 

9 

 

- 

- 

- 

 

9 

41,043 

9 

Other mortgage-backed

3 

2,117 

4 

 

2 

1,330 

15 

 

5 

3,447 

19 

 

Total investment securities

available for sale

60 

$

62,930 

$

150 

 

17 

7,264 

110 

 

77 

70,194 

260 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2007**

 

 

 

 

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

Government-sponsored enterprises

- 

$

- 

$

- 

 

2 

3,476 

8 

 

2 

3,476 

8 

State and municipal

16 

6,135 

79 

 

98 

38,760 

494 

 

114 

44,895 

573 

	Other mortgage-backed

1 

733 

- 

 

15 

10,655 

105 

 

16 

11,388 

105 

 

Total investment securities

available for sale

17 

$

6,868 

$

79 

 

115 

52,891 

607 

 

132 

59,759 

686 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Declines in the fair market value of available-for-salesecurities below cost that are deemed to be other-than-temporary are reflectedin earnings as realized losses. In estimating other-than-temporary impairmentlosses, management considers, among other things, the length of time and theextent to which the fair market value has been less than cost, the financialcondition and near-term prospects of the issuer, and the intent and ability ofthe Company to retain its investment in the issuer for a period of timesufficient to allow for any anticipated recovery in fair value.

 

The Company has the ability and intent to hold thesecurities classified as available for sale for a period of time sufficient fora recovery of cost. The unrealized losses are largely due to increases inmarket interest rates over the yields available at the time the underlyingsecurities were purchased. The fair market value is expected to recover as thebonds approach their maturity date or repricing date or if market yields forsuch investments decline. Management does not believe any of the securities areimpaired due to reasons of credit quality. Accordingly, as of March 31,2008, management believes the impairments detailed in the preceding table aboveare temporary, and, as such, no impairment loss has been realized in theCompany's Consolidated Interim Statements of Income for the three month periodended March 31, 2008.

 

12

 

*Concentrations of Risk*

 

The following table summarizes the fair market value ofgovernment-sponsored enterprise and other mortgage-backed investmentsecurities, by issuer, at March 31, 2008 (in thousands).

 

 

 

**FHLB**

**Federal**

**National**

**Mortgage**

**Association**

**Federal**

**Home Loan**

**Mortgage**

**Corporation**

**Total**

 

 

 

 

 

 

Government-sponsored enterprises

$

7,767 

1,001 

- 

8,768 

Other mortgage-backed

- 

17,238 

4,362 

21,600 

 

 

 

 

 

 

As a percentage of shareholders' equity

6.88% 

16.16 

3.87 

 

 

 

 

 

 

 

 

No collateralized mortgage obligation issuers issued morethan 10% of the total shareholders’ equity at March 31, 2008.  No othermortgage-backed security issuers issued more than 2% of the total shareholders’equity at March 31, 2008.  

 

***4.       Loans***

 

Composition

 

The following table summarizesloans, by loan purpose, excluding those mortgage loans held for sale, byclassification at the dates indicated (dollars in thousands). 

 

 

 

**March 31,**

 

**December 31,**

 

 

**2008**

 

**2007**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

Commercial business

$

157,995 

14.8 

%

145,634 

14.1 

Commercial real estate

660,034 

62.0 

 

639,144 

61.6 

Installment

24,353 

2.3 

 

25,315 

2.5 

Installment real estate

76,990 

7.2 

 

75,721 

7.3 

Indirect

37,972 

3.6 

 

39,502 

3.8 

Credit line

1,956 

0.2 

 

2,188 

0.2 

Prime access

55,561 

5.2 

 

54,164 

5.2 

Residential mortgage

38,216 

3.6 

 

40,842 

3.9 

Bankcards

12,158 

1.1 

 

12,702 

1.2 

Business manager

363 

- 

 

326 

- 

Other

1,494 

0.1 

 

2,045 

0.2 

 

Loans, gross

$

1,067,092 

100.1 

%

1,037,583 

100.0 

Allowance for loan losses

(7,488)

(0.7)

 

(7,418)

(0.7)

Loans in process

5,121 

0.5 

 

6,511 

0.6 

Deferred loans fees and costs

612 

0.1 

 

676 

0.1 

 

Loans, net

$

1,065,337 

100.0 

%

1,037,352 

100.0 

 

 

 

 

 

 

 

 

Loans included in the table are net of participations sold,and mortgage loans sold and serviced for others.  Mortgage loans serviced forthe benefit of others amounted to $347.1 million and  $346.3 million at March31, 2008 and December 31, 2007, respectively. 

 

*Pledged*

 

To borrow from the FHLB, members must pledge collateral tosecure advances.  Acceptable collateral includes a variety of single-familyresidential loans, commercial real estate loans, home equity lines of credit,and multifamily residential loans as well as a number of types of securities. At March 31, 2008, the Company pledged $155 million of its loan portfolio ascollateral to serve against advances from the FHLB.

 

 

* *

13

 
*Concentrations of Risk*
  

  

Loan Type / IndustryConcentration.  TheCompany’s commercial real estate portfolio accounts for 61.5% of the Company’sloan portfolio, excluding those mortgage loans held for sale and theallowance for loan losses.  The following table represents the composition ofproduct types in the commercial real estate portfolio at March 31, 2008.

 

Commercial - specific purpose

31.3 

%

Land

15.4 

 

Residential

15.7 

 

Commercial - owner occupied

15.5 

 

Commercial - nonowner occupied

14.0 

 

Construction

8.1 

 

 

100.0 

%

 

 

 

 

Within these commercial specific properties, concentrationsexist within loans for hotels / motels, religious facilities, and assistedliving facilities. The Company believes that the properties securing itscommercial real estate portfolio are diverse in terms of type. This diversityhelps reduce the Company’s exposure to adverse economic events that impact anysingle industry.

 

Asset Quality

 

Nonaccrual and PastDue 90 Days. The following tablesummarizes nonaccrual loans and loans past due 90 days and still accruinginterest at the dates indicated (in thousands).

 

 

**March 31,**

**December 31,**

**March 31,**

 

**2008**

**2007**

**2007**

Nonaccrual loans

$

5,606 

4,810 

12,137 

Loans past due 90 days and still accruing (1)

260 

236 

243 

 

$

5,866 

5,046 

12,380 

 

 

 

 

(1) Substantially all of these loans are bankcard loans

 

 

 

 

The total additional amount of interest that would have beenreported in income for the three month period ended March 31, 2008 had loansclassified as nonaccrual at this date performed in accordance with theiroriginal terms totaled $227 thousand.  The amount of total interest collectedduring the three month period ended March 31, 2008 relative to loans classifiedas nonaccrual at this date totaled $14 thousand.

 

Troubled Debt Restructurings. Troubled debt restructurings entered into by the Company during the first threemonths of 2008 are subject to review by the Company, in accordance with theCompany’s loan review policies, to ensure loan classifications were inaccordance with applicable regulations.  Any allocations identified during thereview based on probable losses have been included in the Company’s allowancefor loan losses for the applicable period. At March 31, 2008 and December 31,2007, the principal balance of such loans totaled $1.2 million.  

 

Allowance for Loan Losses

 

The allowance for loan losses is a reserve established through a provision forloan losses charged to expense, which represents management's best estimate oflosses that have been incurred within the existing portfolio of loans. Theallowance for loan losses, in the judgment of management, is necessary toreserve for estimated loan losses and risks inherent in the loan portfolio. Thelevel of the allowance for loan losses reflects management's continuingevaluation of industry concentrations, specific credit risks, loan lossexperience, current loan portfolio quality, present economic, political andregulatory conditions, and unidentified losses inherent in the current loanportfolio, as well as trends in the foregoing. Portions of the allowance forloan losses may be allocated for specific credits, however, the entire allowancefor loan losses is available for any credit that, in management's judgment,should be charged-off. While management utilizes its best judgment andinformation available, the ultimate adequacy of the allowance for loan losses isdependent upon a variety of factors beyond the Company’s control, including theperformance of the Company's loan portfolio, the economy, changes in interestrates, and the view of the regulatory authorities toward loan classifications.The table on the following page summarizes the activity impacting the allowance for loanlosses for the periods indicated (in thousands).

 

 

14

 

 

 

 

 

**At and for the three month**

 

 

**periods ended March 31,**

 

 

**2008**

**2007**

Allowance for loan losses, beginning of period

$

7,418 

8,527 

Provision for loan losses

488 

367 

 

 

 

 

Loans charged-off

(447)

(530)

Loan recoveries

29 

96 

 

Net loans charged-off

(418)

(434)

 

 

 

 

Allowance for loan losses, end of period

$

7,488 

8,460 

 

 

 

 

 

Impaired Loans.  The following table summarizes information relative tothe Company’s impaired loans at and for the period indicated (in thousands).Impaired loans without a specific allowance allocation at and for the periodindicated were generally reserved within the allowance for loan losses.

 

 

**At and for the three month**

 

**period ended March 31, 2008**

	Impaired loans, end of period

$

9,177 

	Impaired loans subject to specific reserve allocation, end of period

8,534 

	Impaired loans subject to general reserve allocation, end of period

643 

	Specific allowance allocation on impaired loans, end of period

1,653 

Average impaired loans,	during period

8,422 

 

 

 

As reported in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007, the average balance of impaired loans for2007 was $7.8 million.

 

***5.       Premisesand Equipment, Net***

* *

*Composition*

* *

The following tablesummarizes the Company’spremises and equipment balances at the dates indicated (in thousands).

 

 

 

 

 

**March 31,**

**December 31,**

**March 31,**

 

 

**2008**

**2007**

**2007**

Land

$

7,478 

6,817 

6,685 

Buildings

18,746 

18,440 

17,448 

Leasehold improvements

2,411 

2,247 

2,848 

Furniture and equipment

18,348 

18,054 

17,931 

Software

3,279 

3,273 

3,234 

Bank automobiles

940 

939 

886 

 

Premises and equipment, gross

51,202 

49,770 

49,032 

 

 

 

 

 

	Accumulated depreciation 

(25,105)

(24,637)

(24,030)

 

Premises and equipment, net

$

26,097 

25,133 

25,002 

 

 

 

15

 

 

 

 

 

*Accumulated Depreciation Activity*

* *

The following table summarizes the activity impactingaccumulated depreciation for the periods indicated (in thousands). Depreciationbalances were impacted during the period by the activity discussed herein.

 

 

 

 

**At and for the three month**

 

 

 

**periods ended March 31,**

 

 

 

**2008**

**2007**

Accumulated depreciation, beginning of period

$

24,637 

23,597 

 

 

 

 

 

Depreciation

 

 

 

Buildings

136 

112 

 

Leasehold improvements

30 

40 

 

Furniture and equipment

230 

247 

 

Software

42 

61 

 

Bank automobiles

44 

46 

 

 

Total depreciation

482 

506 

 

 

 

 

 

Disposals

(14)

(73)

 

 

 

 

 

Accumulated depreciation, end of period

$

25,105 

24,030 

 

Long-lived assets to be sold are classified as held for saleand are no longer depreciated. Certain criteria must be met in order for thelong-lived asset to be classified as held for sale including that a sale isprobable and expected to occur within a one year period. Long-lived assetsclassified as held for sale are recorded at the lower of carrying amount orfair market value less the estimated costs to sell. The Company had no suchassets at March 31, 2008.  The Company anticipates that it will classify twoparcels of land, with a book value approximating $1.7 million at March 31,2008, to be purchased from the Company at book value in conjunction with theconstruction of its corporate headquarters in downtown Greenville banking asheld for sale during 2008. 

 

During the first quarter of 2008, the Bank announced that itwould consolidate its existing banking office network from 32 to 28 bankingoffices, effective during the second quarter of 2008. Banking offices locatedat 3695 East North Street in Greenville County, 1490 W.O. Ezell Boulevard inSpartanburg County, and 2915 North Main Street in Anderson County, all of whichwere leased banking offices, were consolidated during April 2008.  Managementis currently evaluating its options with regard to these leased premises.  Consolidationplans with regard to the banking office located at 4513 Main Street (Hodges) inGreenwood County should be complete by the end of the second quarter of 2008. Management is currently considering options with regard to this consolidatedlocation and has not yet concluded whether or not this location will be sold. As such, at March 31, 2008, the long-lived assets associated with thisconsolidated banking office have not been classified as held for sale. Additionally, such assets continue to be depreciated.  Management does notbelieve there will be any impairment write-off associated with this bankingoffice consolidation.

 

During the first quarter of 2008, the Bank celebrated the grand opening of itsrelocated Pendleton banking office in Anderson County.  The Company ownedthe previous Pendleton banking office.  Management is currently consideringoptions with regard to the previous location and has not yet concluded whetheror not this location will be sold.   At March 31,2008, such assets continue to be depreciated and have not been classified asheld for sale.    

 

During the first quarter of 2008, the Bank purchasedproperty at the intersection of West Wade Hampton Boulevard and Middleton Wayin Greenville County on which to construct and relocate its existing Greerbanking office.  The Company expects to celebrate its grand opening of the newGreer banking office during the first quarter of 2009. The Company leases itscurrent Greer banking office and is currently evaluating its options withregard to this leased premise.  

 

***6.       CoreDeposit Intangibles        ***

** **

The following table summarizes thegross carrying amount and accumulated amortization of intangible assets withfinite lives at the dates indicated (in thousands).

 

 

**March 31,**

**December 31,**

 

**2008**

**2007**

Core deposit intangibles, gross

$

1,779 

1,779 

     Less: accumulated amortization

(1,711)

(1,700)

Core deposit intangibles, net

$

68 

79 

 

 

 

 

 

16

 

 

 

***7.       Mortgage-Servicing Rights Portfolio***

 

Mortgage loans serviced for the benefit of others amountedto $347.1 million and  $346.3 million at March 31, 2008 and December 31, 2007,respectively. 

 

Thebook value of the Company’s mortgage-servicing rights portfolio at both March31, 2008 and December 31, 2007 was $2.9 million. The Company’s mortgage-servicing rights portfolio is included in Other Assets on theConsolidated Interim Balance Sheets. Theaggregate fair value of the Company’s mortgage-servicing rights portfolio atMarch 31, 2008 and December 31, 2007 was $3.3 million and $3.6 million,respectively.

 

The amount of servicing fees earned by the Company duringthe three month periods ended March 31, 2008 and 2007 was $216 thousand and$203 thousand, respectively. Servicing fees are included in Mortgage-BankingIncome on the Consolidated Interim Statements of Income.

* *

*Activity*

* *

The following tablesummarizes the changes inthe the Company’s mortgage-servicing rights portfolio for the periods indicated(in thousands). 

 

 

 

 

**At and for the three month**

 

 

 

**periods ended March 31,**

 

 

 

**2008**

**2007**

Mortgage-servicing rights portfolio, net of valuation

 

 

 

allowance, beginning of period

$

2,949 

2,648 

 

 

Capitalized mortgage-servicing rights

165 

203 

 

 

Mortgage-servicing rights portfolio amortization

(213)

(67)

 

 

Change in mortgage-servicing rights portfolio valuation allowance

(3)

1 

Mortgage-servicing rights portfolio, net of valuation

 

 

 

allowance, end of period

$

2,898 

2,785 

 

Mortgage-servicing rights amortizationand valuation allowances are included in Mortgage-Banking Income on theConsolidated Interim Statements of Income.

 

See Consolidated InterimStatements of Cash Flows for a summary of activity impacting the Company’smortgage-servicing rights portfolio.

 

*Valuation Allowance*

 

The following table summarizesthe activity impacting the valuation allowance for impairment of themortgage-servicing rights portfolio for the periods indicated (in thousands).

 

 

 

**At and for the three month**

 

 

**periods ended March 31,**

 

 

**2008**

**2007**

Valuation allowance, beginning of period

$

10 

4 

Aggregate (additions charged to) and reductions credited from operations

3 

(1)

Valuation allowance, end of period

$

13 

3 

 

**8.       *RealEstate and Personal Property Acquired in Settlement of Loans***

* *

*Composition*

* *

The following table summarizes real estate and personal propertyacquired in settlement of loans, which are included in Other Assets on theConsolidated Interim Balance Sheets at the dates indicated (in thousands). 

 
		 **March 31, ****December 31,****March 31,**
 

**2008**

**2007**

**2007**

Real estate acquired in settlement of loans

$

7,960 

7,743 

934 

Repossessed automobiles acquired in settlement of loans

369 

403 

332 

     Total property acquired in settlement of loans

$

8,329 

8,146 

1,266 

* *

17

 

*Activity*

* *

The following table summarizes the changes in the real estateacquired in settlement of loans portfolio, including the balance at the beginningand end of the period, provision charged to expense, and losses charged to theallowance for loan losses related to the Company’s real estate acquired insettlement of loans for the three month period ended March 31, 2008 (inthousands).

 

Real estate acquired in settlement of loans, beginning of period

$

7,743 

 

Add: New real estate acquired in settlement of loans and related adjustments

392 

 

Less: Sales / recoveries of real estate acquired in settlement of loans

(105)

 

Less: Provision charged to expense

(70)

Real estate acquired in settlement of loans, end of period

$

7,960 

 

***9.       Deposits***

* *

*Composition*

* *

The following table summarizesthe Company’s traditional deposit composition at the dates indicated (in thousands).

 

 

 

**March 31,**

**December 31,**

 

 

**2008**

**2007**

Transaction deposit accounts

$

526,375 

522,359 

Money market deposit accounts

113,867 

118,681 

Savings deposit accounts

38,260 

34,895 

Time deposit accounts $100,000 and greater

149,494 

150,398 

Time deposit accounts less than $100,000

227,178 

232,461 

 

Total traditional deposit accounts

$

1,055,174 

1,058,794 

 

At March 31, 2008, $577 thousand of overdrawn transactiondeposit accounts had been reclassified as loan balances compared with $809thousand at December 31, 2007.

* *

Interest Expense on Deposit Accounts

 

The following table summarizes the Company’s interestexpense on traditional deposit accounts costs for the periods indicated (inthousands).

 

 

 

 

**At and for the three month**

 

 

 

**periods ended March 31,**

 

 

 

**2008**

**2007**

Transaction deposit accounts

$

2,029 

2,200 

Money market deposit accounts

776 

980 

Savings deposit accounts

30 

34 

Time deposit accounts

4,281 

4,013 

 

Total interest expense on traditional deposit accounts

$

7,116 

7,227 

 

***10.    Borrowings***

*** ***

FHLB Borrowings

 

During March 2008, the Company began a series of long-termFHLB borrowings intended to support interest-earning asset growth, primarilyinvestments in available for sale securities. Management believes that suchfunding provides the Company with the ability to access the exact type offunding needed, at the exact time, in the exact quantity, and at market rates.This provides the Company with the flexibility to tailor borrowings to itsspecific needs. Although FHLB borrowings do not always result in lower interestexpense, management believes that such funding can increase net interest incomeby employing these funds in higher yield interest-earning assets. To supplementasset growth funding, total long-term FHLB borrowings increased $35.0 millionduring March 2008.  An additional $17.0 million was utilized during April2008.  The table on the following page summarizes theCompany’s long-term borrowings from the FHLB at March 31, 2008 (dollars inthousands).  The Company’s long-term FHLB advance does not have embeddedcall options. 

 

18

 

 

 

 

Total

		Borrowing balance 

$5,000 

 

$30,000 

 

$35,000 

Interest rate

2.57% 

		2.89%

2.84% 

Maturity date

3/8/2010

3/7/2011

 

 

 

The following tablesummarizes the Company’s long-term borrowings from the FHLB at April 30, 2008(dollars in thousands).  The Company’s long-term FHLB advance does nothave embedded call options. 

 

 

 

 

 

 

Total

			Borrowing balance 

 

$5,000 

 

$12,000 

 

$30,000 

 

$5,000 

 

$52,000 

Interest rate

2.57% 

2.75% 

2.89% 

3.61% 

2.90% 

Maturity date

3/8/2010

4/2/2010

3/7/2011

4/2/2013

 

 

 

At March 31, 2008, of itsapproximately $155 million available credit based lendable collateral value toserve against advances from the FHLB, the Company employed advances of $56.5million, $21.5 million of which was determined to be short-term when employedand $35.0 million of which was determined to be long-term when employed, and$69.0 million in a letter of credit used to secure public deposits as requiredor permitted by law.  Short-term FHLB borrowings are included as federal fundspurchased from correspondent banks.  At March 31, 2008, the Company hadapproximately $29 million available credit based lendable collateral value toserve against advances from the FHLB.

 

At December 31, 2007, of itsapproximately $106 million available credit based lendable collateral value toserve against advances from the FHLB, the Company employed advances of $12.0million, all of which was determined to be short-term when employed, and $69.0million in a letter of credit used to secure public deposits as required orpermitted by law.  At December 31, 2007, the Company had approximately $25million available credit based lendable collateral value to serve againstadvances from the FHLB.

 

*Federal Funds Accommodations*

* *

In addition to the FHLBborrowing capacity summarized above, at March 31, 2008, the Company had accessto federal funds funding sources at correspondent banks.  At March 31, 2008,the Company’s accessible funding from correspondent bank federal funds sourceswas $50 million, of which $16.0 million was utilized at March 31, 2008.During April 2008, a correspondent bank increased the Bank’s federal fundsaccommodation by $5 million for a period beginning on April 7, 2008 and endingon March 31, 2009 subject to specified terms and conditions. Advances underthis accommodation are advances of federal funds with a maturity of the nextbanking day. Management intends to extend this accommodation at its maturity. This additional federal funds accommodation in the amount of $5 millionincreased the Company’s accessible funding from correspondent bank federalfunds sources from $50 million to $55 million.

 

***11.    EmployeeBenefit Plans***

*** ***

*Defined Benefit Pension Plan*

 

Plan Freeze.  During the fourth quarter of 2007, the Company notifiedemployees that, effective 2008, it would freeze accrued pension benefits foremployees with regard to the Company’s noncontributory, defined benefitpension plan.  Although no previously accruedbenefits will be lost, employees will no longer accrue benefits for servicesubsequent to 2007. The Company made the decision to freeze its defined benefitpension plan because of the uncertainty of future costs of defined benefitsresulting from such plans being captive to the volatility of capital marketsand the increased burden of government regulation. 

 

19

 

 

 

 

SFAS No. 158 Adoption.  The Company adopted SFAS No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans—anamendment of FASB Statements No. 87, 88, 106, and 132(R),” recognized thefunded status of its defined benefit postretirement plan, and provided theadditional required disclosures as of the year ended December 31, 2007. ThisStatement required, among other things, the recognition of the overfunded orunderfunded status of pension and other postretirement benefit plans on the balance sheet.Under SFAS No. 158, gains and losses, prior service costs and credits, and anyremaining transition amounts under SFAS No. 87, “Employers' Accounting forPensions,” and SFAS No. 106, “Employers' Accounting for Postretirement BenefitsOther Than Pensions,” that had not yet been recognized through net periodicbenefit cost were recognized in accumulated other comprehensive income, net oftax effects, until they are amortized as a component of net periodic cost. Thefollowing table summarizes theadjustments made to accumulated other comprehensive income (loss) (“AOCI(L)”)since the Company’s adoption of SFAS No. 158 during the year ended December 31,2007 (in thousands).

 

 

**Impact of**

**FASB No.**

**158 **

**Impact of**

**freeze**

**Total**

AOCI(L), pre tax, December 31, 2007

$

(6,334)

2,508 

(3,826)

Income tax impact

2,218 

(878)

1,340 

AOCI(L), after tax, December 31, 2007

$

(4,116)

1,630 

(2,486)

 

 

 

 

Change in AOCI(L), pre tax, three month period ended March 31, 2008

$

(531)

- 

(531)

Income tax impact

186 

- 

186 

Change in AOCI(L), after tax, three month period ended March 31, 2008

$

(345)

- 

(345)

 

 

 

 

AOCI(L), pre tax, March 31, 2008

$

(6,865)

2,508 

(4,357)

Income tax impact

2,404 

(878)

1,526 

AOCI(L), after tax, March 31, 2008

$

(4,461)

1,630 

(2,831)

* *

*401(k) Plan*

 

During the three monthperiods ended March 31, 2008 and 2007, the Company made matching contributionsto employee 401(k) plan totaling $91 thousand and $78 thousand, respectively.

 

*CollateralSplit-Dollar Life Insurance Arrangements*

* *

On January 1, 2008, the Companychanged its accounting policy and recognized a cumulative-effect adjustment toretained earnings totaling $99 thousand related to accounting for certaincollateral split-dollar life insurance arrangements in connection with theadoption of EITF No. 06-10. 

 

***12.    EquityBased Compensation***

 

Stock Option Plan

 

General. As of January 2007, all of this plan’soptions had been granted with various expiration dates through December 31,2016.  Of these, 187,155 remained outstanding at March 31, 2008 with exerciseprices ranging from $13.00 to $30.40. All options granted have a vesting termof five years and an exercise period of ten years.  

 

Determining Fair Value. The table on the following page summarizes the stock option awards grantedby the Company, the fair value of each award granted as estimated on thedate of grant using the Black-Scholes option-pricing model, and the weightedaverage assumptions used for such grants for the grant dates indicated. 

 

 

20

 

 

 

Grant Date

1/16/2007

 

 

 

 

 

Stock option awards granted

800 

 

 

 

 

 

Option price

$

30.40 

 

 

 

 

 

Fair value of stock option awards granted

$

6.24 

 

 

 

 

 

Expected dividend yields

2.5 

%

Expected volatility

13 

 

Risk-free interest rate

5 

 

Expected term (years)

10 

 

Vesting period (years)

5 

 

 

The Company’s stock is not listed on an exchange or anyover-the-counter service. Historically, the Company has utilized an annualindependent market valuation to assist the Company in establishing the marketvalue per share of a minority block of the outstanding common shares ofPalmetto Bancshares, Inc. for use in conjunction with stock options.  TheCompany believed that this was the best method to value its stock based on thelack of an active public market in the stock.  However, beginning in 2007,management determined that an average trading price valuation method, based onthe last five known trades of the stock, was a more appropriate estimate of thefair market value of the Company’s common stock.  Management's determinationwas based upon the emergence of a more established, although still limited,trading market in the stock.  All of the stock option awards summarized in thepreceding table were granted prior to this change, which occurred during thesecond quarter of 2007.  

 

Stock Option CompensationExpense. The compensation cost that was charged against pretax net incomefor stock options during the three month periods ended March 31, 2008 and 2007was $23 thousand and $33 thousand, respectively. For both periods, managementestimated that forfeitures would not be significant and recognized compensationcosts for all equity awards.

 

At March 31, 2008, based onoptions outstanding at that time, the total compensation cost related tononvested stock option awards granted under the Company’s stock option plansbut not yet recognized was $165 thousand before the effect of income taxes.Stock option compensation expense is recognized on a straight-line basis overthe vesting period of the option. This cost is expected to be recognized over aremaining period of four years. 

 

Stock Option Activity.The following table summarizes stock option activity for the PalmettoBancshares, Inc. 1997 Stock Compensation Plan for the periods indicated.

 

 

 

 

**Stock options**

**outstanding**

**Weighted-**

**average  **

**exercise **

**price    **

Outstanding at December 31, 2006

251,670 

$

18.67 

 

Granted

800 

30.40 

 

Exercised

(14,510)

12.81 

Outstanding at March 31, 2007

237,960 

$

19.07 

 

 

 

 

 

 

 

 

 

 

Outstanding at December 31, 2007

198,155 

$

20.29 

 

Granted

- 

- 

 

Exercised

(11,000)

10.80 

Outstanding at March 31, 2008

187,155 

$

20.85 

 

Cash received from stock optionexercises under the Company’s stock option plan for the three month periodsended March 31, 2008 and 2007 was $119 thousand and $186 thousand,respectively.

 

The total intrinsic value ofstock options exercised during the three month period ended March 31, 2008 was$332 thousand.  

 

Stock Options Outstanding. The table on the following page summarizes information regarding stock optionsoutstanding and exercisable at March 31, 2008.  

 

21

 

 

 

 

**Options outstanding**

**Options exercisable**

**Exercise price or range of**

**exercise prices**

**Number of**

**stock options**

**outstanding at**

**3/31/08**

**Weighted-**

**average**

**remaining**

**contractual**

**life (years)**

**Weighted-**

**average**

**exercise**

**price**

**Number of**

**stock options**

**exercisable**

**at 3/31/08**

**Weighted-**

**average**

**exercise**

**price**

 

$

13.00 

 

19,620 

1.75 

$

13.00 

19,620 

$

13.00 

 

$

13.50 

 

11,800 

2.75 

13.50 

11,800 

13.50 

$

15.00 

to

$

20.00 

62,135 

4.23 

17.39 

62,135 

17.39 

$

23.30 

to

$

26.60 

58,800 

6.20 

24.75 

38,800 

24.37 

$

27.30 

to

$

30.40 

34,800 

7.76 

27.37 

13,320 

27.37 

 

 

Total

187,155 

5.15 

$

20.85 

145,675 

$

19.26 

 

 

The intrinsic value of stockoptions outstanding and exercisable at March 31, 2008 was $3.2 million. 

 

Restricted Stock Plan

* *

On February 19, 2008, the Company’s Board of Directors adopted, subject to shareholder approval, the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan, which provides for the grant of stock awards to the Company’s employees, officers, and directors.  The Company’s shareholders approved the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan on April 15, 2008. A total of 250,000 shares of common stock have been reserved for issuance pursuant to awards under the Plan, subject to its anti-dilution provisions.  A copy of the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan was attached as Appendix A to the Company’s Proxy Statement dated March 17, 2008 with respect to an Annual Meeting of Shareholders heldon April 15, 2008. No restricted stock awards had been granted at March 31, 2008.

 

***13.    NetIncome per Common Share***

 

The following table summarizes the Company’s reconciliationof the numerators and denominators of the basic and diluted net income percommon share computations for the periods indicated.

 

 

 

**For the three month**

 

 

**periods ended March 31,**

 

 

**2008**

**2007**

Weighted average common shares outstanding - basic

6,431,172 

6,378,516 

 

Dilutive impact resulting from potential common share issuances

87,955 

77,289 

Weighted average common shares outstanding - diluted

6,519,127 

6,455,805 

 

 

 

 

		Common share data

 

 

 

Net income - basic

$

0.57 

0.59 

 

Net income - diluted

0.56 

0.58 

 

As noted previously, beginning in 2007, managementdetermined that an average trading price valuation method, based on the lastfive known trades of the stock, was an appropriate estimate of the fairmarket value of the Company’s common stock.  The dilutive impact resulting frompotential common share issuances for the three month period ended March 31,2007 was calculated prior to this change, which occurred during the secondquarter of 2007.  

 

At March 31, 2008, all outstanding options were included inthe calculation of diluted net income per common share because the exerciseprice of all options was lower than the average market price as determined bythe average trading price of the last five known trades of the Company’s commonstock.

 

***14.    Commitmentsand Contingencies***

 

 

22

 

Standby Letters of Credit

 

At March 31, 2008, the Company recorded no liability for itsobligation to perform as a guarantor under standby letters of credit. Themaximum potential amount of undiscounted future payments related to standbyletters of credit at March 31, 2008 was $11.3 million compared with $11.2million at December 31, 2007.  Past experience indicates that standby lettersof credit will expire unused. However, through its various sources ofliquidity, the Company believes that it has the necessary resources availableto meet these obligations should the need arise.  Additionally, the Companydoes not believe that the current fair value of such guarantees was material atMarch 31, 2008.

 

*Derivatives*

 

See Note15 for further discussion regardingthe Company’s off-balance sheet arrangements and commitments related toderivative loan commitments and its forwardloan sales commitments.  

 

*Real Property Operating LeaseObligations*

 

The Company leases certain officefacilities and real estate relating to banking services under operatingleases.  Rental expense for such operating leases totaled $217 thousand and$186 thousand for the three month periods ended March 31, 2008 and 2007,respectively.  Other than those discussed below, there has been no significantchange in future minimum lease payments payable by the Company since December31, 2007.  

 

The Company enters intoagreements with third parties with respect to the leasing, servicing, and maintenance of equipment. However, the Company believes thatthese agreements are immaterial when considered individually, or in theaggregate, with regard to the Company’s Consolidated Interim FinancialStatements.  Additionally, management believes that noncompliance with terms ofsuch agreements would not have a material impact on the Company’s business,financial condition, results of operations, and cash flows.  Such commitments are generally entered intofor a 12-month period with option extensions.  As such, costs beyond 2008cannot be reasonably estimated at this time.

 

During the first quarter of 2008,the Company executed a building lease and a lease for additional office spacewith regard to its plans to expand into north centralSouth Carolina in the Piedmont region. The Company is currentlyupfitting these leased banking offices and plans to open its first bankingoffice in York County during the second quarter of 2008. Future minimum leasepayments payable by the Company for the remainder of 2008 relative to theselocations approximate $70 thousand.   Although lease payments for periods subsequent to 2008cannot be determined because lease payments depend on consumer price indexchanges, management does not believe that futureminimum lease payments relative to these locations will significantly differfrom those for 2008.  Obligations under these operating lease agreements arepayable over several years with the building lease expiring in 2015 and theadditional office space lease expiring in 2011.  

 

As discussed in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007, the Company plans to relocate its corporateheadquarters to downtown Greenville, South Carolina. The Company anticipatesconstruction will be completed during the fourth quarter of 2008 with the grandopening celebration to follow during the first quarter of 2009.  During 2007,the Company executed a build-to-suit operating lease agreement in conjunctionwith its new corporate headquarters in Greenville County.  Under the termsof the lease agreement, the Lessor will purchase from the Bank two parcels ofland and improvements thereon adjacent to the Lessor's land (one of whichhouses the temporary downtown Greenville banking office during construction). The Lessor will combine the original premises and the newly purchased lesseeproperty and will complete site work, construct improvements, and lease theresulting premises to the Company under the terms and conditions of the leaseagreement. During construction, the Company is continuing to pay real propertyoperating lease payments under its previous lease with the Lessor with regardto its previous downtown Greenville banking office.  Upon occupancy, these realproperty operating lease payments will be replaced with those required by thebuild-to-suit operating lease agreement.  

 

Contractual Capital ExpenditureObligations

 

The renovation ofthe Company’s leased Woodruff Road banking office was substantially completedduring the first quarter of 2008.  The related contractual obligations withregard to this renovation were also materially satisfied during this period. 

 

23

 

 

 

In it Annual Report on Form 10-K for the year ended December31, 2007, the Company estimated that the final stage of its existing Montague bankingoffice renovation and expansion would cost between $450 thousand and $500thousand.  At the time of this filing, the Company’s contractual obligationwith regard to this renovation was not materially satisfied.  Managementapproximates that approximately 40% of the contractual obligation had beensatisfied as of April 2008.  

 

As discussed in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007, the Companyanticipates that it will be required to expend approximately $3 million during2008 with regard to the upfitting of the new corporate headquarters facility tomake it suitable and adequate for the Company’s intended purposes. 

 

Legal Proceedings

 

The Company is currently subject to variouslegal proceedings and claims that have arisen in the ordinary course of itsbusiness. In the opinion of management, based on consultation with externallegal counsel, any reasonably foreseeable outcome of such current litigationwould not materially impact the Company's financial condition or results ofoperations. 

***15.    DerivativeFinancial Instruments and Hedging Activities***

 

As part of its mortgage-banking activities, the Companyoriginates certain mortgage loans and enters into forward sales commitments ofclosed mortgage loans in the secondary market at a future date at a specifiedprice. The commitments to originate mortgage loans and the sales commitmentsare freestanding derivative instruments and are generally funded within90 days. At March 31, 2008, and December 31, 2007, the fair value of theCompany’s derivative assets related to derivativeloan commitments and its forward loan sales commitments were immaterial.

 

***16.     DisclosuresRegarding Fair Value of Financial Instruments***

 

Effective January 1, 2008, the Company adopted SFAS No. 157.SFAS No. 157 defines fair value, establishes a framework for measuring fairvalue, and expands disclosures about fair value measurements.  SFASNo. 157 has been applied prospectively as of the beginning of the period.

 

SFAS No. 157 defines fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurementdate.  SFAS No. 157 also establishes a fair value hierarchy thatrequires an entity to maximize the use of observable inputs and minimize theuse of unobservable inputs when measuring fair value.

 

In accordance with SFAS No.157, the Company groups its financial assets and financial liabilities measuredat fair value in three levels, based on the markets in which the assets andliabilities are traded and the reliability of the assumptions used to determinefair value.  These levels are:
- Level 1 - Valuations for assets and liabilities traded in     active exchange markets, such as the New York Stock     Exchange.  Valuations are obtained from readily available     pricing sources for market transactions involving identical assets or     liabilities.
- Level 2 - Valuations for assets and liabilities traded in     less active dealer or broker markets.  Valuations are obtained     from third party pricing services for identical or comparable assets or     liabilities which use observable inputs other than Level 1 prices, such as     quoted prices for similar assets or liabilities; quoted prices in active     markets that are not active; or other inputs that are observable or can be     corroborated by observable market data for substantially the full term of     the assets or liabilities.

 
- Level 3 - Unobservable inputs that are supported by little     or no market activity and that are significant to the fair value of the     assets or liabilities.

 

The following table presents the Company’s assets that aremeasured at fair value on a recurring basis and the level within the SFAS No.157 hierarchy in which the fair value measurements fall at March 31, 2008 (inthousands).

 

 

 

**Level 1**

**Level 2**

**Level 3**

**Fair value**

Investment securities available for sale

$

- 

$

127,150 

$

- 

$

127,150 

 

 

 

 

 

 

 

24

 

The fair value investment securities available for sale aredetermined by various valuation methodologies.  Where quoted marketprices are available in an active market, securities are classified withinLevel 1. Level 1 securities may include exchange traded equities. If quotedmarket prices are not available, fair values are estimated by using pricingmodels or quoted prices of securities with similarcharacteristics.  Level 2 securities may include U.S. Treasurysecurities, obligations of government corporations and agencies, obligations ofstates and political subdivisions, mortgage-backed securities, collateralizedmortgage obligations, and corporate bonds. In certain cases where Level 1 orLevel 2 inputs are not available, securities are classified within Level 3 ofthe hierarchy and may include subordinated tranches of collateralized mortgageobligations and investments in financial institution trust preferredsecurities.

 

The Company may be required, from time to time, to measurecertain other financial assets and liabilities at fair value on a nonrecurringbasis.  These adjustments to fair value usually result from applicationof lower-of-cost-or-market accounting or writedowns of individualassets.  For assets measured at fair value on a nonrecurring basis inthe first three months of 2008 that were still held in the Consolidated InterimBalance Sheet at March 31, 2008, the following table provides the level ofvaluation assumptions used to determine each adjustment and the fair value ofthe assets at March 31, 2008 (in thousands).

 

 

 

**Level 1**

**Level 2**

**Level 3**

**Fair value**

Impaired loans

$

- 

$

7,523 

$

- 

$

7,523 

 

Loans for which it is probable that the Company will notcollect all principal and interest due according to contractual terms aremeasured for impairment in accordance with the provisions of SFAS No. 114,“Accounting by Creditors for Impairment of a Loan.”  Impaired loans,which are measured for impairment using the fair value of the collateral forcollateral dependent loans, had a carrying amount of $9.2 million, with avaluation allowance of $1.7 million at March 31, 2008.

 

*Fair Value Option*

 

In February 2007, the FASB issuedSFAS No. 159, which permits entities to choose to measure eligibleitems at fair value at specified election dates. Unrealized gains and losses onitems for which the fair value option has been elected are reported in earningsat each subsequent reporting date. The fair value option may be appliedinstrument by instrument, with certain exceptions, is irrevocable (unless a newelection date occurs), and is applied only to entire instruments and notto portions of instruments. The main intent of SFAS No. 159 was to mitigate thedifficulty in determining reported earnings caused by a “mixed-attribute model”(that is, reporting some assets at fair value and others using a differentvaluation method such as amortized cost). The project is separated into twophases. This first phase addresses the creation of a fair value option forfinancial assets and liabilities.  A second phase will addresscreating a fair value option for selected nonfinancial items. SFAS No. 159was effective for the Company on January 1, 2008. The Company has not electedthe fair value option for any financial assets or liabilities at March 31,2008.

 

***17.    RegulatoryCapital Requirements and Dividend Restrictions***

 

*CapitalRequirements*

 

The table on the following page summarizes Palmetto Bancshares’ and the Bank’s actual andrequired capital ratios at the periods indicated (dollars in thousands). As ofMarch 31, 2008, the Company and the Bank were categorized as “well capitalized”under the regulatory framework based on the most recent notification fromfederal banking agencies. As of March 31, 2008, management knew of noconditions or events since the most recent notification from federal bankingagencies that would change the Company’s or the Bank’s category. 

 

25

 

 

 

 

 

 

 

 

**Actual**

**For capital adequacy**

**purposes**

**To be "well capitalized"**

**under prompt**

**corrective action**

**provisions**

 

 

 

 

 

**amount**

**ratio**

**amount**

**ratio**

**amount**

**ratio**

**At March 31, 2008**

 

 

 

 

 

 

 

*Total capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

$

118,915 

10.19% 

93,349 

8.00 

n/a 

n/a 

 

Bank

 

 

118,607 

10.16 

93,349 

8.00 

116,687 

10.00 

 

 

 

 

 

 

 

 

 

 

 

*"Tier 1" capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

111,427 

9.55 

46,675 

4.00 

n/a 

n/a 

 

Bank

 

 

111,119 

9.52 

46,675 

4.00 

70,012 

6.00 

 

 

 

 

 

 

 

 

 

 

 

*"Tier 1" leverage ratio*

 

 

 

 

 

 

 

Company

 

 

111,427 

8.87 

50,259 

4.00 

n/a 

n/a 

 

Bank

 

 

111,119 

8.84 

50,278 

4.00 

62,847 

5.00 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**At December 31, 2007**

 

 

 

 

 

 

*Total capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

$

116,349 

10.27% 

90,669 

8.00 

n/a 

n/a 

 

Bank

 

 

116,186 

10.25 

90,669 

8.00 

113,337 

10.00 

 

 

 

 

 

 

 

 

 

 

 

*"Tier 1" capital to risk-weighted assets*

 

 

 

 

 

 

 

Company

 

 

108,931 

9.61 

45,335 

4.00 

n/a 

n/a 

 

Bank

 

 

108,768 

9.60 

45,335 

4.00 

68,002 

6.00 

 

 

 

 

 

 

 

 

 

 

 

*"Tier 1" leverage ratio*

 

 

 

 

 

 

 

Company

 

 

108,931 

8.97 

48,591 

4.00 

n/a 

n/a 

 

Bank

 

 

108,768 

8.94 

48,652 

4.00 

60,815 

5.00 

* *

 

 

 

26

 

 

 

 

 

**ITEM 2.MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS**

 

Thefollowing discussion and analysis presents the more significant factorsimpacting the Company’s financial condition as of March 31, 2008 and results ofoperations and cash flows for the three month period ended March 31, 2008. Thisdiscussion should be read in conjunction with the Company’s ConsolidatedInterim Financial Statements, and notes thereto, for the year ended December31, 2007, included in the Company’s Annual Report on Form 10-K.  Results forthe three month period ended March 31, 2008 are not necessarily indicative ofthe results for the year ending December 31, 2008 or any future period. Percentage calculations contained herein have been calculated based on actualnot rounded results presented herein.

 

***Development and Description of Business***

** **

*Organization*

* *

Palmetto Bancshares is a regional financial services bank holding companyorganized in 1982 under the laws of South Carolina and headquartered in Laurens,South Carolina that provides, through its subsidiary, the Bank, a broad array ofcommercial banking, consumer banking, trust and investment management, andbrokerage services throughout its market area primarily in Upstate SouthCarolina. 

 

Since Palmetto Bancshares is aholding company and does not conduct operations, its primary sources ofliquidity are dividends upstreamed from its subsidiary bank, fundsreceived through stock option exercises, and fundsreceived through the offering of commercial paper as an alternativeinvestment tool for its commercial customers (master note program).  

 

The Bank was organized andchartered under South Carolina law in 1906. Palmetto Bancshares owns all of theBank’s common stock. The Bank primarily acts as a financial intermediary byattracting deposits from the general public and using those funds, togetherwith borrowed funds, to originate loans and invest in securities.

 

Significant services offered by the Bank include:
- Commercial Banking .   The     Bank provides commercial banking services to corporations and other     business clients. Loans are made for a wide variety of general corporate     purposes, including financing for industrial and commercial properties     and, to a lesser extent, financing for interim construction related to     industrial and commercial properties, financing for equipment, inventories     and accounts receivable, acquisition financing as well as cash management     and merchant services.
- Consumer     Banking.  The Bank provides a full range of consumer banking     services, including checking accounts, savings programs, automated teller     machines, overdraft facilities, installment and real estate loans, home     equity loans and lines of credit, drive-in and night deposit services, and     safe deposit facilities.
- Trust and     Investment Management .   The Bank provides a wide range of     trust, investment, agency, and custodial services for individual and     corporate clients. These services include the administration of estates     and personal trusts, as well as the management of investment accounts for     individuals, employee benefit plans, and charitable foundations. 

 

Additionally, the Bank offers mortgage-servicing services to secondary marketpurchasers in connection with certain mortgage loans the Bank originates forsale.

 

Palmetto Capital is a wholly owned subsidiary of the Bank and providesbrokerage services relating to stocks, treasury and municipal bonds,mutual funds, and insurance annuities, as well as college and retirementplanning through a third party arrangementwith Raymond James. 

 

The Company’s corporate and operating offices are currentlylocated at 301 Hillcrest Drive, Laurens, South Carolina 29360, and its maintelephone number is 864.984.4551. The Company plans to relocate its corporateheadquarters to downtown Greenville, South Carolina. The Company anticipatesconstruction will be completed during the fourth quarter of 2008 with the grandopening celebration to follow during the first quarter of 2009.  Thisrelocation of the corporate offices will not impact the Company’s operatingoffices, which will remain at its existing Laurens location.

 

 

 

27

 

 

*Business Segments*

 

Duringthe three month period ended March 31, 2008, the Company made no changes to itsdetermination in its Annual Report on Form 10-K for the year ended December 31,2007 that it had one reportable operating segment, banking.  As such, separatesegment information is not presented within this Quarterly Report on Form 10-Q.

 

*Employees*

** **

At March 31, 2008, the Company had 413 full-time equivalentemployees, none of whom were subject to collective bargaining agreements,compared with 409 full-time equivalent employees at December 31, 2007. Employees, depending on their level of employment, are offered a comprehensiveemployment program including, but not limited to, medical and dental benefits,life insurance, long-term disability coverage, a 401(k) plan, and variousincentive plans.

 

***Critical Accounting Policies and Estimates***

 

*General*

 

The Company’s accounting andfinancial reporting policies are in conformity, in all material respects, toaccounting principles generally accepted in the United States and to generalpractices within the financial services industry.  The preparation of financialstatements in conformity with such principles requires management to makeestimates and assumptions that impact the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities during thereporting period, and the reported amounts of income and expense during thereporting period.  While the Company bases estimates on historical experience,current information, and other factors deemed to be relevant, actual resultscould differ from those estimates. On an annual basis, management, inconjunction with the Company’s independent registered public accounting firm,discuss the development and selection of the critical accounting estimates withthe Audit Committee of the Company’s Board of Directors.

 

The Company considers accounting policies and estimates to be“critical” to the Company’s financial condition, results of operations, or cashflows if the accounting policy or estimate requires management to makeassumptions about matters that are highly uncertain and differentestimates that management reasonably could have used for the accounting estimatein the current period, or changes in the accounting estimate that arereasonably likely to occur from period to period, could have a material impacton the Company’s financial condition, results of operations, or cash flows. The Company considers the accounting for its allowancefor loan losses, mortgage-servicingrights portfolio, and defined benefit pension plan to be “critical” because of the valuation techniquesused and the sensitivity of the amounts recorded in the Company’s ConsolidatedInterim Financial Statements to the methods, assumptions, and estimatesunderlying these balances. Accounting for these “critical” areas requiressubjective and complex judgments and could be subject to revision as newinformation becomes available. 

 

Foradditional information regarding the Company’s critical accounting policies andestimates, refer to theCompany’s Annual Report on Form 10-K for the Year Ended December 31, 2007. There have been no significant changes in theCompany’s application of critical accounting policies since December 31,2007.

 

***Highlights***

 

Sources and Uses of Funds

 

Loanscontinue to be the largest component of the Company’s mix of assets. Averageloans accounted for 90.5% of average interest-earning assets during the threemonth period ended March 31, 2008 compared with 87.7% during the three monthperiod ended March 31, 2007. Average loans increased$117.5 million, or 12.3%, during the three month period ended March31, 2008 compared with the same period of 2007. 

 

28

 

 

 

 

 

Investment securities available for sale increased $31.4million, or 32.8%, during the first three months of 2008 as the Company beganinvesting in collateralized mortgage obligations. Collateralized mortgageobligations are a mortgage-backed security sub-type in which the mortgages areordered into tranches by some quality (such as repayment time), with eachtranche sold as a separate security. As noted below, during March 2008, theCompany began a series of long-term FHLB borrowings intended to supportinterest-earning asset growth, primarily investments in available for salesecurities. Although FHLB borrowings do not always result in lower interestexpense, management believes that such funding can increase net interest incomeby employing these funds in higher yield interest-earning assets. The Companyused these long-term FHLB borrowings to invest in collateralized mortgageobligations, which management believes are undervalued in the currentmarketplace.  In addition, management believes that the “margin of safety” onthese investments is at unprecedented levels due to the market discount thathas been applied to the entire mortgage related marketplace.  In spite of thesepurchases, average investment securities available for sale accounted for 8.7%of average interest-earning assets during the three month period ended March31, 2008 compared with 10.5% during the same period of 2007. Average investment securities available for sale decreased $11.2 million, or 9.9%, during thethree month period ended March 31, 2008 compared withthe same period of 2007. Absent these collateralized mortgage obligationpurchased in conjunction with this leverage transaction, the relativeproportion of funds invested in investment securities available for sale decreased when comparing the periods presented as theCompany employed the proceeds from maturing investment securities tofund loan growth. 

 

Traditional deposit accounts continue to be the Company’sprimary source of funding.  Average traditional deposit accounts increased$55.3 million, or 5.5% during the three monthperiod ended March 31, 2008 compared with the sameperiod of 2007.  Average nontraditionaldeposit accounts, including retail repurchase agreements and commercial paper,supplement the Company’s source of funding provided through traditional depositaccounts.  Such accounts increased $9.2 million, or 25.5% over the sameperiods.  The combination of increasing competition and alternative investmentoptions has made it more difficult to grow deposits accounts, both traditional andnontraditional. To supplement funding provided through deposit accounts,management has primarily employed proceeds from maturing investment securitiesissued by government-sponsored enterprises and borrowed funds to fund loangrowth.   

 

The Company has found wholesale funding, which includesfederal funds purchased from correspondent banks and FHLB advances, to be alogical answer to supplement asset growth funding when funding through depositsis insufficient. Management believes that such funding provides the Companywith the ability to access the exact type of funding needed, at the exact time,in the exact quantity, and at market rates. This provides the Company with theflexibility to tailor borrowings to its specific needs. During March 2008, theCompany began a series of long-term FHLB borrowings intended to supportinterest-earning asset growth, primarily investments in available for salesecurities. Although FHLB borrowings do not always result in lower interestexpense, management believes that such funding can increase net interest incomeby employing these funds in higher yield interest-earning assets. To supplementasset growth funding, total wholesale funding increased $42.5 million duringthe three month period ended March 31, 2008, $35.0 million of which waslong-term.  An additional $17.0 million in long-term FHLB borrowings wasutilized during April 2008.  

 

At March 31, 2008, of itsapproximately $155 million available credit based lendable collateral value toserve against advances from the FHLB, the Company employed advances of $56.5million, $21.5 million of which was determined to be short-term when employedand $35.0 million of which was determined to be long-term when employed, and$69.0 million in a letter of credit used to secure public deposits as requiredor permitted by law.  At March 31, 2008, the Company had approximately $29million available credit based lendable collateral value to serve againstadvances from the FHLB.

 

In addition to the FHLBborrowing capacity summarized above, at March 31, 2008, the Company had accessto federal funds funding sources at correspondent banks.  At March 31, 2008,the Company’s accessible funding from correspondent bank federal funds sourceswas $50 million, of which $16.0 million was utilized at March 31, 2008. DuringApril 2008, a correspondent bank increased the Bank’s federal fundsaccommodation by $5 million for a period beginning on April 7, 2008 and endingon March 31, 2009 subject to specified terms and conditions. Advances underthis accommodation are advances of federal funds with a maturity of the nextbanking day. Management intends to extend this accommodation at its maturity. This additional federal funds accommodation in the amount of $5 millionincreased the Company’s accessible funding from correspondent bank federalfunds sources from $50 million to $55 million.

 
Highlights of Net Income
 

Net income decreased $115 thousand, or 3.1%,	from the three month period ended March 31, 2007 to the same period of 2008. 	The following table summarizes the components of net income for the three	month periods ended March 31, 2008 and 2007 (in thousands).  

 

 
 
**For the three month**
 
 
 
 
 
**periods ended March 31,**
**Dollar**
**Percent**
 
 
 
**2008**
**2007**
**variance**
**variance**
 
 
 
 
 
 
 
 
Interest income
$
20,240 
20,198 
42 
0.2 
%
Interest expense
7,691 
7,735 
(44)
(0.6)
 
 
Net interest income
12,549 
12,463 
86 
0.7 
 
Provision for loan losses
488 
367 
121 
33.0 
 
 
Net interest income after provision for loan losses
12,061 
12,096 
(35)
(0.3)
 
Noninterest income
4,689 
3,899 
790 
20.3 
 
Noninterest expense
11,167 
10,209 
958 
9.4 
 
 
Net income before provision for income taxes
5,583 
5,786 
(203)
(3.5)
 
Provision for income taxes
1,937 
2,025 
(88)
(4.3)
 
 
Net income
$
3,646 
3,761 
(115)
(3.1)
%
       
 
 

Highlights of Net Interest Income. 

 

Net interest income for the three month period ended March 31, 2008 was $12.5million, an increase of $81 thousand, or 0.6%, compared with the three monthperiod ended March 31, 2007. The table on the following page summarizes thedollar amount of changes in interest income and interest expense attributableto changes in average volume and the amount attributable to changes in averageinterest rates when comparing the three month period ended March 31, 2008 tothe three month period ended March 31, 2007 (in thousands).  The impact of thecombination of rate and volume change has been divided proportionately betweenthe rate change and volume change. The comparison between the periods includesan additional change factor that summarizes the impact of the difference in thenumber of days in each period.

 

 

29

 

 

 

 

 

**Change in**

**average**

**volume**

**Change in**

**average**

**rate**

**Change due**

**to**

**difference**

**in number**

**of days**

**Total**

**change**

Total interest income

$

576 

(702)

168 

42 

Total interest expense

994 

(1,101)

63 

(44)

 

Net interest income

$

(418)

399 

105 

86 

 

The Federal Reserve influences thegeneral market rates of interest rates earned on interest-earning assets andinterest rates paid on interest-bearing liabilities. The Company’s loanportfolio is significantly impacted by changes in the prime interest rate, andits borrowings portfolio is significantly impacted by changes in the federalfunds interest rate, which is the cost of immediately available overnightfunds. The following table summarizes the actions taken by the FederalReserve with regard to the prime interest rate and the federal funds interestrate for the three month periods ended March 31, 2007 and March 31, 2008. 

 

 

**Prime**

**rate**

 

**Federal**

**funds rate**

Rate, at December 31, 2006

8.25 

%

5.25 

 

 

 

 

Changes in rate

- 

 

- 

 

 

 

 

Rate, at March 31, 2007

8.25 

%

5.25 

 

 

 

 

 

 

 

 

Rate, at December 31, 2007

7.25 

%

4.25 

 

 

 

 

Changes in rate

(2.00)

 

(2.00)

 

 

 

 

Rate, at March 31, 2008

5.25 

%

2.25 

 

 

 

 

 

As discussed in Item 3.Quantitative and Qualitative Disclosures about Market Risk, management’s evaluationof its net interest income simulation prepared as of March 31, 2008 indicatedthat the Company’s balance sheet is liability sensitive. A liability sensitivebalance sheet suggests that in falling interest rate environment, net interestmargin would be positively impacted.

 

 
Provision for Loan Losses.
 

See Asset Quality and Allowance for Loan Lossesincluded elsewhere in this item for discussion of the factors impacting theprovision for loan losses for the three month period March 31, 2008.

 
Highlights of Noninterest Income.
 

The following table summarizes the components ofnoninterest income for the three month periods ended March 31, 2008 and 2007 (inthousands).

 

 
 
 
 
 
 
 
 
 
 
**For the three month periods**
 
 
 
 
 
**ended March 31,**
**Dollar**
**Percent**
 
 
 
**2008**
**2007**
**variance**
**variance**
 
Service charges on deposit accounts
$
2,167 
1,908 
259 
13.6 
%
		Fees for trust and investment management and brokerage services
756 
696 
60 
8.6 
 
Mortgage-banking income
253 
348 
(95)
(27.3)
 
Other
1,513 
947 
566 
59.8 
 
 
Total noninterest income
$
4,689 
3,899 
790 
20.3 
%
 
 
 
 
 
 
 
 

During the first quarter of 2008, the Companyrecorded a pretax first quarter gain of approximately $226 thousand, recordedwithin Other Noninterest Income on the Consolidated Interim Statements ofIncome, resulting from the mandatory redemption of a portion of its Class BVisa, Inc. shares as part of Visa's recent initial public offering.  TheCompany continues to own 8,386 shares of Visa Class B shares that areconvertible into Class A shares. 

 
Highlights of Noninterest Expense.
 

The following table summarizes the components ofnoninterest expense for the three month periods ended March 31, 2008 and 2007(in thousands).

 

 
 
 
 
 
 
 
 
 
 
**For the three month periods**
 
 
 
 
 
**ended March 31,**
**Dollar**
**Percent**
 
 
 
**2008**
**2007**
**variance**
**variance**
 
Salaries and other personnel
$
6,195 
6,137 
58 
0.9 
%
Occupancy
421 
370 
51 
13.8 
 
Furniture and equipment
1,328 
1,277 
51 
4.0 
 
Marketing
332 
268 
64 
23.9 
 
Amortization of core deposit intangibles
11 
12 
(1)
(8.3)
 
Other
2,880 
2,145 
735 
34.3 
 
 
Total noninterest expense
$
11,167 
10,209 
958 
9.4 
%
 
 
 
 
 
 
 
 

The following table summarizes significantfluctuations within Other Noninterest Expense during the three month periodended March 31, 2008 over the same period of 2007 (in thousands).

 

 
 
**For the three month periods**
 
 
 
**ended March 31,**
**Dollar**
 
 
**2008**
**2007**
**variance**
Federal Deposit Insurance Corporation assessment
$
165 
40 
125 
Sundry losses
99 
(127)
226 
Real estate acquired in settlement of loans writedowns
360 
166 
194 
 
 
$
624 
79 
545 
 

30

 

 

 

 

 

As reported in the Company’s Annual Report onForm 10-K for the year ended December 31, 2007, in November 2006, the FederalDeposit Insurance Corporation (“FDIC”) adopted final regulations that setdeposit insurance assessment rates that took effect in 2007. The Bankreceived a one-time assessment credit of $576 thousand that could be appliedagainst future premiums, beginning in 2007, subject to certain limitations.Any remaining credit could be used to offset upto 90% of subsequent annual assessments through 2010. The increase in FDICpremiums during the three month period ended March 31, 2008 over the same periodof 2007 was due to the fact that during the 2007 quarter, the Company was ableto utilize its one-time assessment credit againstdeposit insurance assessments due.  

 

During the second quarter of 2006, as a resultof a software upgrade, the Company experienced a temporary delay in checkprocessing and electronic check processing.  At December 31, 2006, the Bankhad exposure, and reserved for in Other Noninterest Expense in the ConsolidatedInterim Statements of Income, of approximately $174 thousand related to itemsuncollected at that date.  Subsequently, during the first three months of2007, the Bank collected virtually all of these items.  Therefore, thisreserve was reversed during the first quarter of 2007.

 

During the first quarter of 2008, the Companyrecorded $360 thousand in writedowns related to its real estate acquired insettlement of loans portfolio primarily as the result of costs associated withthe holding of one commercial property within the portfolio.

 

Asset Quality

 

The following table summarizes thematerial trends in asset quality for the periods indicated.

 

 

**At and for the three month**

**periods ended March 31,**

 

**At and for the**

**year ended**

**December 31,**

 

**2008**

 

**2007**

 

**2007**

Classified assets as a percentage of loans (1)

1.8 

%

2.4 

 

1.4 

Nonaccrual loans as a percentage of loans and foreclosed assets (1)

0.52 

 

1.27 

 

0.46 

Nonaccrual loans as a percentage of total assets

0.43 

 

1.03 

 

0.39 

Nonperforming assets as a percentage of loans and foreclosed assets (1)

1.29 

 

1.40 

 

1.23 

Nonperforming assets as a percentage of total assets

1.08 

 

1.14 

 

1.04 

Net loans charged-off as a percentage of average loans (1)

0.16 

 

0.19 

 

0.21 

 

 

 

 

 

 

(1) Loans calculated excluding mortgage loans held for sale, net of unearned income, excluding allowance for loan losses.

 

See Financial Condition – LendingActivities, included elsewhere in this item, for discussion of factors impacting these trends inasset quality. 

 

Allowance for Loan Losses

 

The allowance for loanlosses increased slightly from $7.4 million at December 31, 2007 to $7.5million at March 31, 2008, declining from 0.71% to 0.70% of loans,respectively, calculated using loans excluding mortgage loans held for sale andthe allowance for loan losses, net of unearned income. The ratio of theallowance for loan losses to loans decreased one basis point from December 31,2007 to March 31, 2008 due, in part, to the overall growth in the loanportfolio.  Additionally, management believes that this ratio was impacted bythe Company’s asset quality indicators, a selection of which are presented inthe preceding Asset Quality section. Despite the decline in this ratio,management believes the level of the allowance for loan losses continues toremain adequate.  Should any of the factors considered by management inevaluating the adequacy of the allowance for loan losses change, the Company’sestimate of loan losses could also change, which could impact the level offuture provisions for loan losses.

 

31

 

 

Other First Quarter Highlights

 

CollateralSplit-Dollar Life Insurance Arrangements. On January 1, 2008, the Company changed its accounting policy andrecognized a cumulative-effect adjustment to retained earnings totaling$99 thousand related to accounting for certain collateral split-dollarlife insurance arrangements in connection with the adoption of EITF No. 06-10.

 

Restricted Stock Plan. On February 19, 2008, the Company’s Board ofDirectors adopted, subject to shareholder approval, the Palmetto Bancshares,Inc. 2008 Restricted Stock Plan, which provides for the grant of stock awards to theCompany’s employees, officers, and directors.  The Company’s shareholdersapproved the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan on April 15,2008. A total of 250,000 shares of common stock have been reserved for issuancepursuant to awards under the Plan, subject to its anti-dilution provisions.  Acopy of the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan was attachedas Appendix A to the Company’s Proxy Statement dated March 17, 2008 withrespect to an Annual Meeting of Shareholders held on April 15, 2008. Norestricted stock awards had been granted at March 31, 2008.

 

Property Highlights. During the first quarter of 2008, the Bank:  
- Announced that it would consolidate its existing banking     office network from 32 to 28 banking offices, effective during the second     quarter of 2008. Banking offices located at 3695 East North Street in     Greenville County, 1490 W.O. Ezell Boulevard in Spartanburg County, and     2915 North Main Street in Anderson County, all of which were leased     banking offices, were consolidated during April 2008.  Management is     currently evaluating its options with regard to these leased premises.  Consolidation     plans with regard to the banking office located at 4513 Main Street     (Hodges) in Greenwood County should be complete by the end of the second     quarter of 2008.  Management is currently considering options with regard     to this consolidated location and has not yet concluded whether or not     this location will be sold.  
- Opened its relocated Pendleton banking office in Anderson     County.  
- Purchased property at the intersection of West Wade     Hampton Boulevard and Middleton Way in Greenville County on which to     construct and relocate its existing Greer banking office. 
- Executed a building lease and a lease for additional     office space with regard to its plans to expand into north central South Carolina in the Piedmont region.     The Company is currently upfitting these leased banking offices and plans     to open its first banking office in York County during the second quarter     of 2008. 
- Substantially completed the renovation of the Company’s leased Woodruff Road banking     office.  
- Continued the final stage of its existing Montague banking     office renovation and expansion.  

 

 

 

 

Additional Property Highlights.  As discussed in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2007, theCompany plans to relocate its corporate headquarters to downtown Greenville,South Carolina. The Company anticipates construction will be completed duringthe fourth quarter of 2008 with the grand opening celebration to follow duringthe first quarter of 2009.  During 2007, the Company executed a build-to-suit operatinglease agreement in conjunction with its new corporate headquarters inGreenville County.  Under the terms of the lease agreement, the Lessorwill purchase from the Bank two parcels of land and improvements thereonadjacent to the Lessor's land (one of which houses the temporary downtownGreenville banking office during construction).  The Lessor will combinethe original premises and the newly purchased lessee property and will completesite work, construct improvements, and lease the resulting premises to theCompany under the terms and conditions of the lease agreement. Duringconstruction, the Company is continuing to pay real property operating leasepayments under its previous lease with the Lessor with regard to its previousdowntown Greenville banking office.  Upon occupancy, these real propertyoperating lease payments will be replaced with those required by thebuild-to-suit operating lease agreement.  

 

The Company anticipates that itwill be required to expend approximately $3 million during 2008 with regard tothe upfitting of the new corporate headquarters facility to make it suitableand adequate for the Company’s intended purposes. 

 

32

 

***Financial Condition*****

* *

*Overview*

* *

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

 

**Consolidated Balance Sheets**

 

**(dollars in thousands)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**March 31,**

 

**December 31,**

 

**Dollar**

 

**Percent**

 

 

 

 

 

 

 

**2008**

 

**2007**

 

**variance**

 

**variance**

 

 

 

 

 

 

 

		(unaudited)

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

 

$

32,972 

 

42,450 

 

(9,478)

 

(22.3)

%

 

Federal funds sold

 

 

974 

 

9,782 

 

(8,808)

 

(90.0)

 

 

 

Total cash and cash equivalents

 

33,946 

 

52,232 

 

(18,286)

 

(35.0)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB stock, at cost

 

 

4,788 

 

2,617 

 

2,171 

 

83.0 

 

Investment securities available for sale, at fair market value

127,150 

 

95,715 

 

31,435 

 

32.8 

 

Mortgage loans held for sale

 

 

11,804 

 

5,006 

 

6,798 

 

135.8 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

 

 

 

1,072,825 

 

1,044,770 

 

28,055 

 

2.7 

 

 

Less: allowance for loan losses

 

(7,488)

 

(7,418)

 

(70)

 

0.9 

 

 

 

Loans, net

 

 

1,065,337 

 

1,037,352 

 

27,985 

 

2.7 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Premises and equipment, net

 

 

26,097 

 

25,133 

 

964 

 

3.8 

 

Goodwill

 

 

 

 

3,691 

 

3,691 

 

- 

 

- 

 

Core deposit intangibles

 

 

68 

 

79 

 

(11)

 

(13.9)

 

Accrued interest receivable

 

 

6,518 

 

6,655 

 

(137)

 

(2.1)

 

Other

 

 

 

 

16,376 

 

19,697 

 

(3,321)

 

(16.9)

 

 

 

 

Total assets

 

 

$

1,295,775 

 

1,248,177 

 

47,598 

 

3.8 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing

 

 

$

134,943 

 

135,111 

 

(168)

 

(0.1)

%

 

Interest-bearing

 

 

920,231 

 

923,683 

 

(3,452)

 

(0.4)

 

 

 

Total deposits

 

 

1,055,174 

 

1,058,794 

 

(3,620)

 

(0.3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail repurchase agreements

 

 

15,798 

 

11,280 

 

4,518 

 

40.1 

 

Commercial paper (Master notes)

 

29,425 

 

26,326 

 

3,099 

 

11.8 

 

Other short-term borrowings

 

 

37,500 

 

30,000 

 

7,500 

 

25.0 

 

Long-term borrowings

 

 

35,000 

 

- 

 

35,000 

 

100.0 

 

Accrued interest payable

 

 

1,916 

 

2,042 

 

(126)

 

(6.2)

 

Other

 

 

 

 

8,126 

 

9,479 

 

(1,353)

 

(14.3)

 

 

 

Total liabilities

 

 

1,182,939 

 

1,137,921 

 

45,018 

 

4.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

32,164 

 

32,109 

 

55 

 

0.2 

 

Capital surplus

 

 

1,829 

 

1,664 

 

165 

 

9.9 

 

Retained earnings

 

 

81,481 

 

79,221 

 

2,260 

 

2.9 

 

Accumulated other comprehensive loss, net of tax

 

(2,638)

 

(2,738)

 

100 

 

(3.7)

 

 

 

Total shareholders' equity

 

112,836 

 

110,256 

 

2,580 

 

2.3 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,295,775 

 

1,248,177 

 

47,598 

 

3.8 

%

 

*Lending Activities*

* *

Composition.  Thefollowing table summarizes net loans, by loan purpose, excluding those mortgageloans held for sale, by classification at the dates indicated (dollars inthousands). 

 

 

 

**March 31,**

 

**December 31,**

 

 

**2008**

 

**2007**

 

 

**Total**

**% of**

**total**

 

**Total**

**% of**

**total**

Commercial business

$

157,995 

14.8 

%

145,634 

14.1 

Commercial real estate

660,034 

62.0 

 

639,144 

61.6 

Installment

24,353 

2.3 

 

25,315 

2.5 

Installment real estate

76,990 

7.2 

 

75,721 

7.3 

Indirect

37,972 

3.6 

 

39,502 

3.8 

Credit line

1,956 

0.2 

 

2,188 

0.2 

Prime access

55,561 

5.2 

 

54,164 

5.2 

Residential mortgage

38,216 

3.6 

 

40,842 

3.9 

Bankcards

12,158 

1.1 

 

12,702 

1.2 

Business manager

363 

- 

 

326 

- 

Other

1,494 

0.1 

 

2,045 

0.2 

 

Loans, gross

$

1,067,092 

100.1 

%

1,037,583 

100.0 

Allowance for loan losses

(7,488)

(0.7)

 

(7,418)

(0.7)

Loans in process

5,121 

0.5 

 

6,511 

0.6 

Deferred loans fees and costs

612 

0.1 

 

676 

0.1 

 

Loans, net

$

1,065,337 

100.0 

%

1,037,352 

100.0 

 

 

Loans included in the table are net of participations sold,and mortgage loans sold and serviced for others.  Mortgage loans serviced forthe benefit of others amounted to $347.1 million and  $346.3 million at March31, 2008 and December 31, 2007, respectively. 

 

	33

 

 

Pledged.**To borrow from the FHLB, members mustpledge collateral to secure advances.  Acceptable collateral includes a varietyof single-family residential loans, commercial real estate loans, home equitylines of credit, and multifamily residential loans as well as a number of typesof securities.  At March 31, 2008, the Company pledged $155 million of its loanportfolio as collateral to serve against advances from the FHLB.

 

Concentrations of Risk.  Loan Type / IndustryConcentration. As noted above, the Company’s commercial real estate portfolioaccounts for 61.5% of the Company’s loan portfolio, excluding thosemortgage loans held for sale and the allowance for loan losses.  The followingtable represents the composition of product types in the commercial real estateportfolio at March 31, 2008.

 

Commercial - specific purpose

31.3 

%

Land

15.4 

 

Residential

15.7 

 

Commercial - owner occupied

15.5 

 

Commercial - nonowner occupied

14.0 

 

Construction

8.1 

 

 

100.0 

%

 

Within these commercial specific properties, concentrationsexist within loans for hotels / motels, religious facilities, and assistedliving facilities. The Company believes that the properties securing itscommercial real estate portfolio are diverse in terms of type. This diversityhelps reduce the Company’s exposure to adverse economic events that impact anysingle industry.

 

Asset Quality.  The table on the following page summarizes the composition ofthe Company’s classified assets, by collateral type, at the dates indicated (dollars in thousands).

 

34

 

 

 

**March 31, 2008**

 

 

 

**Special**

**mention**

 

**Substandard**

**Doubtful**

**Loss**

**Total**

 

**As a**

**percentage**

**of loans (1)**

 

Commercial and industrial

$

566 

 

1,443 

800 

- 

2,809 

 

0.3 

%

 

 

 

 

 

 

 

 

 

 

 

Real estate - single family

232 

 

3,876 

171 

- 

4,279 

 

0.4 

 

Real estate - construction

- 

 

184 

- 

- 

184 

 

0.0 

 

Real estate - other

2,484 

 

7,980 

629 

- 

11,093 

 

1.0 

 

 

Total loans secured by real estate

2,716 

 

12,040 

800 

- 

15,556 

 

1.5 

 

 

 

 

 

 

 

 

 

 

 

 

General consumer and other

30 

 

366 

21 

- 

417 

 

0.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total classified loans

$

3,312 

 

13,849 

1,621 

- 

18,782 

 

1.8 

%

 

 

 

 

 

 

 

 

 

 

 

As a percentage of loans (1)

0.3 

%

1.3 

0.2 

- 

1.8 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**December 31, 2007**

 

 

 

**Special**

**mention**

 

**Substandard**

**Doubtful**

**Loss**

**Total**

 

**As a**

**percentage**

**of loans (1)**

 

Commercial and industrial

$

118 

 

1,451 

647 

- 

2,216 

 

0.2 

%

 

 

 

 

 

 

 

 

 

 

 

Real estate - single family

176 

 

3,646 

370 

- 

4,192 

 

0.4 

 

Real estate - construction

- 

 

182 

- 

- 

182 

 

0.0 

 

Real estate - other

1,578 

 

6,033 

461 

- 

8,072 

 

0.8 

 

 

Total loans secured by real estate

1,754 

 

9,861 

831 

- 

12,446 

 

1.2 

 

 

 

 

 

 

 

 

 

 

 

 

General consumer and other

20 

 

322 

29 

- 

371 

 

0.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total classified loans

$

1,892 

 

11,634 

1,507 

- 

15,033 

 

1.4 

%

 

 

 

 

 

 

 

 

 

 

 

As a percentage of loans (1)

0.2 

%

1.1 

0.1 

- 

1.4 

%

 

 

 

 

 

 

 

 

 

 

 

 

(1) Calculated using loans excluding mortgage loans held for sale, net of unearned, excluding the allowance for loan losses

 

The majority of the increase in classified assets at March31, 2008 over December 31, 2007 can be attributed to the addition of two loanrelationships to the classified asset portfolio, one being graded as specialmention and the other being graded as substandard.  

 

Impacting the increase in assets classified as “specialmention” at March 31, 2008 over December 31, 2007 was the addition of a retailfacility loan relationship totaling $1.8 million.  As a precautionary measure,this loan was downgraded as a result of cash flow analysis.  However, managementbelieves that, from a market value perspective, the securing commercial realestate loan collateral is sufficient to cover the Bank’s exposure.  Proceedsfrom past and future sales of outparcels are being used to reduce the debt. 

 

Impacting the increase in assets classified as “substandard”at March 31, 2008 over December 31, 2007 was the addition of a participationrelationship for which the Bank’s exposure totals $744 thousand.  This loanfunded golf course communities including both courses and residential lots. When the borrower’s ability to cover debt service payments slowed, the leadbank in this participation arrangement and the borrower developed a debtrepayment plan which involves the sale of the golf courses in addition to theongoing sale of the residential lots.  Management believes the securingcommercial real estate loan collateral is sufficient to cover the Bank’sexposure.  

 

NonperformingAssets. The table on the following page summarizes trends in nonperforming assets at the dates indicated (dollars inthousands). The composition of nonaccrual loans is based on loan collateraltype.

35

 

 

 

 

 

**March 31,**

 

**December 31,**

**March 31,**

 

 

**2008**

 

**2007**

**2007**

 

 

 

 

 

 

Real estate

$

4,857 

 

4,127 

11,507 

Commercial and industrial

631 

 

567 

530 

General consumer and other

118 

 

116 

100 

 

Total nonaccrual loans

5,606 

 

4,810 

12,137 

 

 

 

 

 

 

Real estate acquired in settlement of loans

7,960 

 

7,743 

934 

Repossessed automobiles		acquired in settlement of loans

369 

 

403 

332 

 

Total foreclosed assets

8,329 

 

8,146 

1,266 

 

 

 

 

 

 

 

Total nonperforming assets

$

13,935 

 

12,956 

13,403 

 

 

 

 

 

 

Loans past due 90 days and still accruing (1)

$

176 

 

236 

243 

 

 

 

 

 

 

Loans (2)

$

1,072,825 

 

1,044,770 

954,221 

 

 

 

 

 

 

Total assets

1,295,775 

 

1,248,177 

1,173,497 

 

 

 

 

 

 

Nonaccrual loans as a percentage of:

 

 

 

 

 

loans and foreclosed assets (2)

0.52 

%

0.46 

1.27 

 

total assets

0.43 

 

0.39 

1.03 

 

 

 

 

 

 

Nonperforming assets as a percentage of:

 

 

 

 

 

loans and foreclosed assets (2)

1.29 

 

1.23 

1.40 

 

total assets

1.08 

 

1.04 

1.14 

 

 

 

 

 

 

(1)

Substantially all of these loans are bankcard loans

 

 

 

(2)

Calculated using loans excluding mortgage loans held for sale, net of unearned, excluding the allowance for loan losses

 

During the first quarter of 2007, two loans, both of whichwere secured by other real estate, were placed in nonaccrual status.  At March31, 2007, the principal balance of these loans totaled $5.3 million.  DuringJuly 2007, the Company completed foreclosure proceedings with regard to thereal estate collateral securing both loans that had been previously classifiedas nonaccrual.  Both properties, totaling $5.3 million, were placed into theBank’s real estate in settlement of loans portfolio in July at fair marketvalue. One property, totaling $2.2 million was sold from the Company’s realestate in settlement of loans portfolio during 2007.  In addition to the secondsuch property that remained in the Company’s real estate in settlement of loansportfolio at December 31, 2007, during the fourth quarter of 2007, the Companycompleted foreclosure proceedings with regard to the real estate collateralsecuring one loan that had been previously classified as “substandard” duringthe fourth quarter of 2005.   This property was transferred into the Bank’sreal estate in settlement of loans portfolio during 2007 at its fair marketvalue. 

 

The following table summarizes the changes in the real estateacquired in settlement of loans portfolio, including the balance at thebeginning and end of the period, provision charged to expense, and lossescharged to the allowance for loan losses related to the Company’s real estateacquired in settlement of loans for the three month period ended March 31, 2008(in thousands).

 

Real estate acquired in settlement of loans, beginning of period

$

7,743 

 

Add: New real estate acquired in settlement of loans and related adjustments

392 

 

Less: Sales / recoveries of real estate acquired in settlement of loans

(105)

 

Less: Provision charged to expense

(70)

Real estate acquired in settlement of loans, end of period

$

7,960 

 

36

 

 

 

 

 

Real estate acquired in settlement of loans remained relatively unchanged duringthe first three months of 2008.  Two loan relationships compriseapproximately 91% of the real estate acquired in settlement of loans portfolio. Both loan relationships are secured by other real estate for which foreclosureproceedings were completed during the third quarter of 2007 and  during the fourth quarter of 2007,respectively. With regard to the property added to the portfolio duringthe third quarter, the lead bank is currently marketing this property for saleand believes it has several interest parties.  Management expects the proceedsfrom the sale to cover the Company’s exposure.  The property placed into thereal estate acquired in settlement of loans portfolio during the fourth quarterwas the Bank’s purchase portion of a participation arrangement.  The lead bankis managing the operations of the property and iscurrently working with an external firm to develop a plan to market theproperty.  The Bank was a 20% participant in the loan relationship and is now a20% owner of the collateral property. 

 

Troubled debt restructuringsentered into by the Company during the first three months of 2008 are subjectto review by the Company, in accordance with the Company’s loan reviewpolicies, to ensure loan classifications were in accordance with applicableregulations.  Any allocations identified during the review based on probablelosses have been included in the Company’s allowance for loan losses for theapplicable period. At March 31, 2008 and December 31, 2007, the principalbalance of such loans totaled $1.2 million.  

 

Potentialproblem loans consist of loans that are generally performing in accordance withcontractual terms but for which management has concerns about the ability ofthe borrower to continue to comply with repayment terms because of theborrower’s potential operating or financial difficulties. Management monitorsthese loans closely and reviews performance on a regular basis. As of March 31,2008, the Company had potential problem loans totaling $7.4 million that werenot already categorized as nonaccrual. 

 

Allowance for Loan Losses. Impaired Loans.  The following tablesummarizes information relative to the Company’s impaired loans at and for theperiod indicated (in thousands). Impaired loans without a specific allowanceallocation at and for the period indicated were generally reserved within theallowance for loan losses.

 

 

**At and for the three month**

 

**period ended March 31, 2008**

		Impaired loans, end of period

$

9,177 

		Impaired loans subject to specific reserve allocation, end of period

8,534 

		Impaired loans subject to general reserve allocation, end of period

643 

		Specific allowance allocation on impaired loans, end of period

1,653 

Average impaired loans,		during period

8,422 

 

As reported in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007, the average balance of impaired loans for2007 was $7.8 million.

 

Activity. The table on the following page summarizes activity within theallowance for loan losses at the dates and for the periods indicated (dollarsin thousands). Losses and recoveries are charged or credited to the allowancefor loan losses at the time realized. 

 

37

 

 

 

 

**At and for the three month**

**periods ended March 31,**

 

**At and for**

**the year**

**ended**

**December**

**31,**

 

 

 

**2008**

 

**2007**

 

**2007**

Allowance for loan losses, beginning of period

$

7,418 

 

8,527 

 

8,527 

 

 

 

 

 

 

 

 

Provision for loan losses

488 

 

367 

 

988 

 

 

 

 

 

 

 

 

Loans charged-off

 

 

 

 

 

 

Commercial and industrial

125 

 

106 

 

505 

 

Real estate - single family

77 

 

87 

 

371 

 

Real estate - construction

- 

 

- 

 

- 

 

Real estate - other

13 

 

107 

 

496 

 

General consumer and other

232 

 

230 

 

991 

 

 

Total loans charged-off

447 

 

530 

 

2,363 

 

 

 

 

 

 

 

 

Recoveries

 

 

 

 

 

 

Commercial and industrial

8 

 

18 

 

54 

 

Real estate - single family

2 

 

3 

 

39 

 

Real estate - construction

- 

 

- 

 

- 

 

Real estate - other

1 

 

1 

 

13 

 

General consumer and other

18 

 

74 

 

160 

 

 

Total recoveries

29 

 

96 

 

266 

 

 

 

 

 

 

 

 

 

 

Net loans charged-off

418 

 

434 

 

2,097 

 

 

 

 

 

 

 

 

Allowance for loan losses, end of period

$

7,488 

 

8,460 

 

7,418 

 

 

 

 

 

 

 

 

Average loans (1)

$

1,062,952 

 

949,102 

 

986,518 

 

 

 

 

 

 

 

 

Ending loans (1)

1,072,825 

 

954,221 

 

1,044,770 

 

 

 

 

 

 

 

 

Nonaccrual loans

5,606 

 

12,137 

 

4,810 

 

 

 

 

 

 

 

 

Net loans charged-offs as a percentage of average loans (1)

0.16 

%

0.19 

 

0.21 

 

 

 

 

 

 

 

 

Allowance for loan losses as a percentage of ending loans (1)

0.70 

 

0.89 

 

0.71 

 

 

 

 

 

 

 

 

Allowance for loan losses as a percentage of nonaccrual loans

133.57 

 

69.70 

 

154.22 

 

 

 

 

 

 

 

 

(1)

Calculated using loans excluding mortgage loans held for sale, net of unearned income, excluding allowance for loan losses

 

 

The allowance for loan losses is a reserve establishedthrough a provision for loan losses charged to expense, which representsmanagement's best estimate of losses that have been incurred within theexisting portfolio of loans. The allowance for loan losses, in the judgment ofmanagement, is necessary to reserve for estimated loan losses and risksinherent in the loan portfolio. The level of the allowance for loan lossesreflects management's continuing evaluation of industry concentrations,specific credit risks, loan loss experience, current loan portfolio quality,present economic, political and regulatory conditions, and unidentified lossesinherent in the current loan portfolio, as well as trends in the foregoing.Portions of the allowance for loan losses may be allocated for specificcredits, however, the entire allowance for loan losses is available for anycredit that, in management's judgment, should be charged-off. While managementutilizes its best judgment and information available, the ultimate adequacy ofthe allowance for loan losses is dependent upon a variety of factors beyond theCompany’s control, including the performance of the Company's loan portfolio,the economy, changes in interest rates, and the view of the regulatoryauthorities toward loan classifications. 

 

Management believes thatthat the declining trend of the allowance for loan losses as a percentage ofending loans, excluding mortgage loans held for sale, net of unearned income,results from improving credit quality factors during the three month periodended March 31, 2008 over the same period of 2007.  Management believes thatsuch improvement is the result of several factors including, but not limited to,management’s conservative philosophy regarding its underwriting and lendingmix, the ongoing management of asset quality, and growth within the portfoliobeing primarily loans secured by real estate which generally involve less riskthan other types of lending. Despitethe decline in this ratio, management believes the level of the allowance forloan losses continues to remain adequate.  Should any of the factors consideredby management in evaluating the adequacy of the allowance for loan losseschange, the Company’s estimate of loan losses could also change, which couldimpact the level of future provisions for loan losses.

 

38

 

 

 

Investment Activities

 

The following tablesummarizes the composition of the Company’s investment securities available forsale portfolio at the dates indicated (dollars in thousands).

 

 

 

**March 31, 2008**

 

**December 31, 2007**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

Government-sponsored enterprises

$

8,768 

6.9% 

 

20,743 

		21.7 

State and municipal

52,167 

41.0 

 

52,159 

		54.5 

Collateralized mortgage obligations

44,615 

35.1 

 

- 

		- 

Other mortgage-backed

21,600 

17.0 

 

22,813 

		23.8 

 

Total investment securities available for sale

$

127,150 

100.0% 

 

95,715 

		100.0 

 

Thefollowing table summarizes the amortized cost and fair market value compositionof the Company’s investment securities available for sale portfolio at thedates indicated (in thousands).

 

 

 

 

**March 31, 2008**

 

**December 31, 2007**

 

 

 

**Amortized**

**Fair market**

 

**Amortized**

**Fair market**

 

 

 

**cost**

**value**

 

**cost**

**value**

Government-sponsored enterprises

$

8,746 

8,768 

 

20,725 

20,743 

State and municipal

52,161 

52,167 

 

52,677 

52,159 

Collateralized mortgage obligations

44,622 

44,615 

 

- 

- 

Other mortgage-backed

21,311 

21,600 

 

22,722 

22,813 

Total investment securities available for sale

$

126,840 

127,150 

 

96,124 

95,715 

 

Approximately 58% of the investment securities portfolio waspledged to secure public deposits and trust assets as of March 31, 2008 ascompared with 80% at December 31, 2007.  Of the Company’s $127.2 millionavailable for sale investment securities balance at March 31, 2008, $53.3million was unpledged and, therefore, available as a liquidity source. Of theCompany’s $95.7 million available for sale investment securities balance atDecember 31, 2007, $19.1 million was unpledged and, therefore, available as aliquidity source. The decrease in pledged securities as a percentage of theinvestment securities portfolio from December 31, 2007 to March 31, 2008 wasthe result of an increase in the investment security portfolio.  Investmentsecurities pledged to secure public deposits and trust assets at of March 31,2008 totaled $73.9 million, relatively unchanged from $76.6 million at December31, 2007.

 

Impairment Analysis.**The following tablesummarizes the gross unrealized losses, fair market value, and the number ofsecurities in each category of investment securities available for sale,aggregated by investment category and length of time that individual securitieshave been in a continuous unrealized loss position, at March 31, 2008 andDecember 31, 2007 (dollars in thousands).

 

 

 

**March 31, 2008**

 

 

**Less than 12 months**

 

**12 months or longer**

 

**Total**

 

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

 

**#**

**Fair**

**market**

**value**

**Gross**

**unrealized**

**losses**

Government-sponsored enterprises

- 

$

- 

$

- 

 

- 

- 

- 

 

- 

- 

- 

State and municipal

48 

19,770 

137 

 

15 

5,934 

95 

 

63 

25,704 

232 

Collateralized mortgage obligation

9 

41,043 

9 

 

- 

- 

- 

 

9 

41,043 

9 

Other mortgage-backed

3 

2,117 

4 

 

2 

1,330 

15 

 

5 

3,447 

19 

 

Total investment securities

available for sale

60 

$

62,930 

$

150 

 

17 

7,264 

110 

 

77 

70,194 

260 

 

Declines in the fair market value of available-for-salesecurities below cost that are deemed to be other-than-temporary are reflectedin earnings as realized losses. In estimating other-than-temporary impairmentlosses, management considers, among other things, the length of time and theextent to which the fair market value has been less than cost, the financialcondition and near-term prospects of the issuer, and the intent and ability ofthe Company to retain its investment in the issuer for a period of timesufficient to allow for any anticipated recovery in fair value.

 

39

 

The Company has the ability and intent to hold thesecurities classified as available for sale for a period of time sufficient fora recovery of cost. The unrealized losses are largely due to increases inmarket interest rates over the yields available at the time the underlyingsecurities were purchased. The fair market value is expected to recover as thebonds approach their maturity date or repricing date or if market yields forsuch investments decline. Management does not believe any of the securities areimpaired due to reasons of credit quality. Accordingly, as of March 31,2008, management believes the impairments detailed in the preceding table aboveare temporary, and, as such, no impairment loss has been realized in theCompany's Consolidated Interim Statements of Income for the three month periodended March 31, 2008.

 

 

*Concentrations of Risk*

 

The following table summarizes the fair market value ofgovernment-sponsored enterprise and other mortgage-backed investmentsecurities, by issuer, at March 31, 2008 (in thousands).

 

 

 

 

**FHLB**

**Federal**

**National**

**Mortgage**

**Association**

**Federal**

**Home Loan**

**Mortgage**

**Corporation**

**Total**

 

 

 

 

 

 

 

 

Government-sponsored enterprises

$

7,767 

1,001 

- 

8,768 

 

Other mortgage-backed

- 

17,238 

4,362 

21,600 

 

 

 

 

 

 

 

 

As a percentage of shareholders' equity

6.88% 

16.16 

3.87 

 

 

No collateralized mortgage obligation issuers issued morethan 10% of the total shareholders’ equity at March 31, 2008.  No othermortgage-backed security issuers issued more than 2% of the total shareholders’equity at March 31, 2008.  

 

*Deposit Activities*

* *

The following tablesummarizes the Company’s traditional deposit composition at the datesindicated (dollars in thousands).

 

 

 

**March 31,**

 

**December 31,**

 

 

**2008**

 

**2007**

 

 

**Total**

**% of total**

 

**Total**

**% of total**

Noninterest-bearing transaction deposit accounts

$

134,943 

12.8 

%

135,111 

12.8 

Interest-bearing transaction deposit accounts

391,432 

37.1 

 

387,248 

36.5 

 

Transaction deposit accounts

526,375 

49.9 

 

522,359 

49.3 

 

 

 

 

 

 

 

Money market deposit accounts

113,867 

10.8 

 

118,681 

11.2 

Savings deposit accounts

38,260 

3.6 

 

34,895 

3.3 

Time deposit accounts

376,672 

35.7 

 

382,859 

36.2 

 

Total traditional deposit accounts

$

1,055,174 

100.0 

%

1,058,794 

100.0 

 

Dependence ontraditional deposit account funding declined from December 31, 2007 to March31, 2008.  At December 31, 2007, traditional deposit accounts as a percentageof liabilities were 93.0% compared with 89.2% at March 31, 2008. Thedecline in the percentage of funding provided by traditional deposit accountsduring the first three months of 2008 resulted in the Company relying moreheavily on alternative funding sources from which to fund asset growth. 

 

 

40

 

 

 

The table set forth belowsummarizes the average balances of interest-bearingtraditional deposit accounts by type and the weighted average rates paidthereon for the periods indicated (dollars in thousands).

 

 

 

 

 

 

**For the three month periods ended March 31,**

 

 

 

 

**2008**

 

 

**2007**

 

 

 

**Average**

**balance**

**Interest**

**expense**

**Weighted**

**average**

**rate paid**

 

**Average**

**balance**

**Interest**

**expense**

**Weighted**

**average**

**rate paid**

Transaction deposit accounts

$

		390,028 

2,029 

2.09 

%

		330,181 

2,200 

2.70 

Money market deposit accounts

114,327 

776 

2.73 

 

117,217 

980 

3.39 

Savings deposit accounts

36,011 

30 

0.34 

 

42,183 

34 

0.33 

Time deposit accounts

380,869 

4,281 

4.52 

 

377,549 

4,013 

4.31 

 

Total interest-bearing traditional deposit accounts

$

		921,235 

7,116 

3.11 

%

		867,130 

7,227 

3.38 

* *

*Borrowing Activities*

* *

In addition totraditional deposit accounts, which are the Company’s primary fundingsource for asset growth, the Companyborrows funds as an economical way tosupplement its supply of lendable funds, to assist in meeting depositwithdrawal requirements, and to fund growth of interest-earning assetsin excess of traditional deposit growth.Management believes that by locking in term funding, liquidity risk can bereduced. 

 

The Company’s reliance on borrowed funds increased by $42.5million during the first three months of 2008 because alternative fundingsources were inadequate to cover asset growth. Borrowings as a percentage oftotal liabilities were approximately 6.1% and 5.9% at March 31, 2008 andDecember 31, 2007, respectively. 

 

The following tablesummarizes the Company’s borrowings composition at the dates indicated (dollarsin thousands).

 

 

 

**March 31, 2008**

 

**December 31, 2007**

 

 

 

**Total**

**% of total**

 

**Total**

**% of total**

 

Retail repurchase agreements

$

15,798 

13.4 

%

11,280 

16.7 

 

Commercial paper

29,425 

25.0 

 

26,326 

38.9 

 

 

Total nontraditional deposit accounts

45,223 

38.4 

 

37,606 

55.6 

 

 

 

 

 

 

 

 

 

Other short-term borrowings

37,500 

31.9 

 

30,000 

44.4 

 

Long-term borrowings

35,000 

29.7 

 

- 

- 

 

 

Total wholesale funding

72,500 

61.6 

 

30,000 

44.4 

 

 

 

 

 

 

 

 

 

 

Total borrowed funds

$

117,723 

100.0 

%

67,606 

100.0 

 

 

FHLBBorrowings. During March 2008, the Company began a series oflong-term FHLB borrowings intended to support interest-earning asset growth,primarily investments in available for sale securities. Management believesthat such funding provides the Company with the ability to access the exacttype of funding needed, at the exact time, in the exact quantity, and at marketrates. This provides the Company with the flexibility to tailor borrowings toits specific needs. Although FHLB borrowings do not always result in lowerinterest expense, management believes that such funding can increase netinterest income by employing these funds in higher yield interest-earningassets. To supplement asset growth funding, total long-term FHLB borrowingsincreased $35.0 million during March 2008.  An additional $17.0 million wasutilized during April 2008.  The followingtable summarizes the Company’s long-term borrowings from the FHLB at March 31,2008 (dollars in thousands).  The Company’s long-term FHLB advance doesnot have embedded call options. 

 

 

 

 

Total

		Borrowing balance 

 

$5,000 

 

$30,000 

 

$35,000 

Interest rate

2.57% 

2.89% 

2.84% 

Maturity date

3/8/2010

3/7/2011

 

 

 

The following tablesummarizes the Company’s long-term borrowings from the FHLB at April 30, 2008(dollars in thousands).  The Company’s long-term FHLB advance does nothave embedded call options. 

 

 

 

 

 

 

Total

		Borrowing balance 

 

$5,000 

 

$12,000 

 

$30,000 

 

$5,000 

 

$52,000 

Interest rate

2.57% 

2.75% 

2.89% 

3.61% 

2.90% 

Maturity date

3/8/2010

4/2/2010

3/7/2011

4/2/2013

 

 

41

 

At March 31, 2008, of itsapproximately $155 million available credit based lendable collateral value toserve against advances from the FHLB, the Company employed advances of $56.5million, $21.5 million of which was determined to be short-term when employedand $35.0 million of which was determined to be long-term when employed, and$69.0 million in a letter of credit used to secure public deposits as requiredor permitted by law.  Short-term FHLB borrowings are included as federal fundspurchased from correspondent banks.  At March 31, 2008, the Company hadapproximately $29 million available credit based lendable collateral value toserve against advances from the FHLB.

 

At December 31, 2007, of itsapproximately $106 million available credit based lendable collateral value toserve against advances from the FHLB, the Company employed advances of $12.0million, all of which was determined to be short-term when employed, and $69.0million in a letter of credit used to secure public deposits as required orpermitted by law.  At December 31, 2007, the Company had approximately $25million available credit based lendable collateral value to serve againstadvances from the FHLB.

 

Federal FundsAccommodations. In addition to the FHLB borrowing capacity summarizedabove, at March 31, 2008, the Company had access to federal funds fundingsources at correspondent banks.  At March 31, 2008, the Company’s accessiblefunding from correspondent bank federal funds sources was $50 million, of which$16.0 million was utilized at March 31, 2008.  During April 2008, acorrespondent bank increased the Bank’s federal funds accommodation by $5million for a period beginning on April 7, 2008 and ending on March 31, 2009subject to specified terms and conditions. Advances under this accommodationare advances of federal funds with a maturity of the next banking day.Management intends to extend this accommodation at its maturity.  Thisadditional federal funds accommodation in the amount of $5 million increasedthe Company’s accessible funding from correspondent bank federal funds sourcesfrom $50 million to $55 million.

 

*Capital*

* *

General. The following table summarizes capitalresource key performance indicators at andfor the periods indicated (dollars in thousands, except common and pershare data).

 

 
 
**At and for the three monthperiods ended March 31** 
**2008** 
**2007**Total shareholders' equity$  112,836 103,175Average shareholders' equity112,714 102,120    Total shareholders' equity to total		assets8.7
%8.8Average shareholders' equity as a		percentage of average total assets8.9 8.8    Cash dividends per common share$   0.20 0.19Dividend payout ratio35.30
%32.25
 

The Company’s dividend payout ratio calculates thepercentage of earnings paid to shareholders in dividends. 

 

 

 

 

 

42

 

The following table summarizes activity impactingshareholders’ equity at and for the periodindicated (in thousands).

 

 

 

 

 

 

**At and for the three month**

 

 

 

**period ended March 31, 2008**

Shareholders' equity, beginning of period

$

110,256 

 

 

 

 

Additions to shareholders' equity

 

 

Net income

3,646 

 

Net unrealized gains on investment securities

445 

 

Stock option activity

142 

 

		Excess tax benefit from stock-based awards

		78 

 

 

Total additions to shareholders' equity

		4,311 

 

 

 

 

Reductions in shareholders' equity

 

 

Cumulative effect of adoption of new accounting standard EITF 06-10

(99)

 

Net unrealized losses on defined benefit pension plan assets

(345)

 

Cash dividends declared and paid

(1,287)

 

 

Total reductions in shareholders' equity

(1,731)

 

 

 

 

Shareholders' equity, end of period

$

		112,836 

 

AccumulatedOther Comprehensive Income (Loss). The Company adopted SFAS No. 158,  recognized the funded status of itsdefined benefit postretirement plan, and provided the additional requireddisclosures as of the year ended December 31, 2007. This Statement required,among other things, the recognition of the overfunded or underfunded status ofpension and other postretirement benefit plans on the balance sheet. Under SFASNo. 158, gains and losses, prior service costs and credits, and any remainingtransition amounts under SFAS No. 87 and SFAS No. 106 that had not yet beenrecognized through net periodic benefit cost were recognized in accumulatedother comprehensive income, net of tax effects, until they are amortized as acomponent of net periodic cost. During the first quarter of 2008, the Companyrecorded a pretax adjustment to the funded status of its defined benefitpostretirement plan totaling $531 thousand.  The after tax impact to the Company’saccumulated other comprehensive income totaled $345 thousand.

 

Thefollowing table summarizes the components of accumulated other comprehensiveincome (loss) at March 31, 2008.

 

Investment securities available for sale

$

193 

Defined benefit pension plan

(2,831)

 

Shareholders' equity, end of period

$

(2,638)

 

Regulatory Capital Requirements. Under regulatoryrequirements, reported accumulated other comprehensive income / loss amounts donot increase or reduce regulatory capital and are not included in thecalculation of risk-based capital and leverage ratios. The Company and the Bankare required to meet regulatory capital requirements that currently includeseveral measures of capital.  As of March 31, 2008, the Company and the Bank werecategorized as “well capitalized” under the regulatory framework based on themost recent notification from federal banking agencies. Since March 31, 2008, there were no conditions or events of which management has beenmade aware that would materially change the Company’s or the Bank’s status.

 

***Derivative Activities***

*** ***

As part of its mortgage-banking activities, the Companyoriginates certain mortgage loans and enters into forward sales commitments ofclosed mortgage loans in the secondary market at a future date at a specifiedprice. The commitments to originate mortgage loans and the sales commitmentsare freestanding derivative instruments and are generally funded within90 days. At March 31, 2008, the fair value of the Company’s derivativeassets related to derivative loan commitments and itsforward loan sales commitments were immaterial. 

 

***Liquidity***

** **

Cash Flow Needs

                   

Standby Letters ofCredit.**At March 31, 2008, the Company recorded no liability forits obligation to perform as a guarantor under standby letters of credit. Themaximum potential amount of undiscounted future payments related to standbyletters of credit at March 31, 2008 was $11.3 million compared with $11.2million at December 31, 2007.  Past experience indicates that standby lettersof credit will expire unused. However, through its various sources ofliquidity, the Company believes that it has the necessary resources availableto meet these obligations should the need arise.  Additionally, the Companydoes not believe that the current fair value of such guarantees was material atMarch 31, 2008.

 

 

43

 
Derivatives.* *See DerivativeActivities, includedelsewhere in this item, for further discussion regarding the Company’soff-balance sheet arrangements and commitments related to derivative loancommitments and its forward loan sales commitments.  
 

Dividend Obligations. Forthe three month periods ended March 31, 2008 and 2007, cash dividends weredeclared by the Company’s Board of Directors and paid totaling $1.3 million, or$0.20 per common share, and $1.2 million, or $0.19 per common share, respectively. The Company has historically paid dividends on a quarterly basis. Thesedividends equate to dividend payout ratios of 35.30% and 32.25% for the sameperiods. The Company’s dividend payout ratio calculates the percentage ofearnings paid to shareholders in dividends. TheCompany’s Board of Directors is currently committed to continuing to pay regular cashdividends.  However, there can be no assurance as to future dividends becausethey are dependent on the Company’s financial condition, results of operations,cash flows, as well as capital and dividendregulations.  

 

Real Property Operating LeaseObligations. The Company leases certain office facilities and real estaterelating to banking services under operating leases.  Rental expense for suchoperating leases totaled $217 thousand and $186 thousand for the three monthperiods ended March 31, 2008 and 2007, respectively.  Other than thosediscussed below, there has been no significant change in future minimum leasepayments payable by the Company since December 31, 2007.  

 

The Company enters intoagreements with third parties with respect to the leasing, servicing, andmaintenance of equipment. However,the Company believes that these agreements are immaterial when consideredindividually, or in the aggregate, with regard to the Company’s ConsolidatedInterim Financial Statements.  Additionally, management believes thatnoncompliance with terms of such agreements would not have a material impact onthe Company’s business, financial condition, results of operations, andcash flows.  Such commitments are generallyentered into for a 12-month period with option extensions.  As such, costsbeyond 2008 cannot be reasonably estimated at this time.

 

During the first quarter of 2008,the Company executed a building lease and a lease for additional office spacewith regard to its plans to expand into north centralSouth Carolina in the Piedmont region. The Company is currentlyupfitting these leased banking offices and plans to open its first bankingoffice in York County during the second quarter of 2008. Future minimum leasepayments payable by the Company for the remainder of 2008 relative to theselocations approximate $70 thousand.   Although lease payments forperiods subsequent to 2008 cannot be determined because lease payments depend onconsumer price index changes, management does not believe that futureminimum lease payments relative to these locations will significantly differfrom those for 2008.  Obligations under these operating lease agreements arepayable over several years with the building lease expiring in 2015 and theadditional office space lease expiring in 2011.  

 

As discussed in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2007, the Company plans to relocate its corporateheadquarters to downtown Greenville, South Carolina. The Company anticipatesconstruction will be completed during the fourth quarter of 2008 with the grandopening celebration to follow during the first quarter of 2009.  During 2007,the Company executed a build-to-suit operating lease agreement in conjunctionwith its new corporate headquarters in Greenville County.  Under the termsof the lease agreement, the Lessor will purchase from the Bank two parcels ofland and improvements thereon adjacent to the Lessor's land (one of whichhouses the temporary downtown Greenville banking office duringconstruction).  The Lessor will combine the original premises and thenewly purchased lessee property and will complete site work, construct improvements,and lease the resulting premises to the Company under the terms and conditionsof the lease agreement. During construction, the Company is continuing to payreal property operating lease payments under its previous lease with the Lessorwith regard to its previous downtown Greenville banking office.  Uponoccupancy, these real property operating lease payments will be replaced withthose required by the build-to-suit operating lease agreement.  

 

44

 

Contractual CapitalExpenditure Obligations.**The renovation of the Company’s leasedWoodruff Road banking office was substantially completed during the firstquarter of 2008.  The related contractual obligations with regard to thisrenovation were also materially satisfied during this period.  

 

In it Annual Report on Form 10-K for the year ended December31, 2007, the Company estimated that the final stage of its existing Montaguebanking office renovation and expansion would cost between $450 thousand and$500 thousand.  At the time of this filing, the Company’s contractualobligation with regard to this renovation was not materially satisfied. Management approximates that approximately 40% of the contractual obligationhad been satisfied as of April 2008.  

 

 

As discussed in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007, the Companyanticipates that it will be required to expend approximately $3 million during2008 with regard to the upfitting of the new corporate headquarters facility tomake it suitable and adequate for the Company’s intended purposes. 

 

***Earnings Review ***

Overview

 

45

 

**PALMETTO BANCSHARES, INC. AND SUBSIDIARY**

 

**Consolidated Interim Statements of Income**

 

**(dollars in thousands, except common and per share data)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the three month**

 

 

 

 

 

 

 

 

 

 

 

**periods ended March 31,**

 

**Dollar**

 

**Percent**

 

 

 

 

 

 

 

**2008**

 

**2007**

 

**variance**

 

**variance**

 

 

 

 

 

 

 

		(unaudited)

 

 

 

 

 

Interest income

 

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

19,051 

 

18,766 

 

285 

 

1.5 

%

 

Interest on investment securities available for sale

1,090 

 

1,171 

 

(81)

 

(6.9)

 

 

Dividends on FHLB stock

 

57 

 

37 

 

20 

 

54.1 

 

 

Interest earned on federal funds sold

37 

 

208 

 

(171)

 

(82.2)

 

 

Interest earned on cash and due from banks

5 

 

16 

 

(11)

 

(68.8)

 

 

 

 

Total interest income

 

20,240 

 

20,198 

 

42 

 

0.2 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

Interest on deposits

 

7,116 

 

7,227 

 

(111)

 

(1.5)

 

 

Interest on retail repurchase agreements

112 

 

146 

 

(34)

 

(23.3)

 

 

Interest on commercial paper

 

144 

 

238 

 

(94)

 

(39.5)

 

 

Interest on other short-term borrowings

251 

 

29 

 

222 

 

765.5 

 

 

Interest on long-term borrowings

68 

 

95 

 

(27)

 

(28.4)

 

 

 

 

Total interest expense

 

7,691 

 

7,735 

 

(44)

 

(0.6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

12,549 

 

12,463 

 

86 

 

0.7 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

488 

 

367 

 

121 

 

33.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

12,061 

 

12,096 

 

(35)

 

(0.3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest income

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

2,167 

 

1,908 

 

259 

 

13.6 

 

 

Fees for trust and investment management and brokerage services

756 

 

696 

 

60 

 

8.6 

 

 

Mortgage-banking income

 

253 

 

348 

 

(95)

 

(27.3)

 

 

Other

 

 

 

1,513 

 

947 

 

566 

 

59.8 

 

 

 

 

Total noninterest income

4,689 

 

3,899 

 

790 

 

20.3 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense

 

 

 

 

 

 

 

 

 

 

Salaries and other personnel

 

6,195 

 

6,137 

 

58 

 

0.9 

 

 

Occupancy

 

 

421 

 

370 

 

51 

 

13.8 

 

 

Furniture and equipment

 

1,328 

 

1,277 

 

51 

 

4.0 

 

 

Marketing

 

 

332 

 

268 

 

64 

 

23.9 

 

 

Amortization of core deposit intangibles

11 

 

12 

 

(1)

 

(8.3)

 

 

Other

 

 

 

2,880 

 

2,145 

 

735 

 

34.3 

 

 

 

 

Total noninterest expense

11,167 

 

10,209 

 

958 

 

9.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

5,583 

 

5,786 

 

(203)

 

(3.5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

1,937 

 

2,025 

 

(88)

 

(4.3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

3,646 

 

3,761 

 

(115)

 

(3.1)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common share data

 

 

 

 

 

 

 

 

 

 

Net income - basic

 

$

0.57 

 

0.59 

 

(0.02)

 

(3.4)

%

 

Net income - diluted

 

0.56 

 

0.58 

 

(0.02)

 

(3.4)

 

 

Cash dividends

 

0.20 

 

0.19 

 

0.01 

 

5.3 

 

 

Book value

 

 

17.54 

 

16.17 

 

1.37 

 

8.5 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding - basic

6,431,172 

 

6,378,516 

 

 

 

 

 

 

Weighted average common shares outstanding - diluted

6,519,127 

 

6,455,805 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest margin forthe three month period ended March 31, 2008 was 4.28% compared with 4.66% forthe three month period ended March 31, 2007. Average interest-earning assetsincreased $95.5 million, or 8.8% over the same periods.

 

Earnings resulted in areturn on average shareholders’ equity of 13.01% and 14.94% for the three monthperiods ended March 31, 2008 and 2007. Return on average assets was 1.16% and1.32% for the same periods.

 

Net Interest Income

 

General. Net interest income is the differencebetween interest income earned on interest-earning assets, primarily loans andinvestment securities, and interest expense paid on interest-bearing depositsand other interest-bearing liabilities.  This measure represents the largestcomponent of income for the Company. The net interest margin measures howeffectively the Company manages the difference between the interest incomeearned on interest-earning assets and the interest expense paid for funds tosupport those assets. Changes in interest rates earned on interest-earningassets and interest rates paid on interest-bearing liabilities, the rate ofgrowth of the interest-earning assets and interest-bearing liabilities base,the ratio of interest-earning assets to interest-bearing liabilities, and themanagement of interest rate sensitivity factor into changes in net interestincome.

 

46

 

 

 

Average Balance Sheets and Net Interest Income / MarginAnalysis. The following table summarizes the Company’s average balancesheets and net interest income analysis for the periods indicated (dollars inthousands). The Company's interest yield earned on interest-earning assets andinterest rate paid on interest-bearing liabilities shown in the table arederived by dividing interest income and expense by the average balances ofinterest-earning assets or interest-bearing liabilities. The following tabledoes not include a tax-equivalent adjustment to net interest income forinterest-earning assets earning tax-exempt income to a comparable yield on ataxable basis.

 

 
 
 
 
For the three month periods ended			March 31,
 
 
 
 
2008
 
2007
** **
 
 
 
 
Average 
Income/ 
Yield/ 
 
Average 
Income/ 
 Yield/  
** **
 
 
 
 
balance
expense
rate
 
balance
expense
 rate 
** **
Assets
 
 
 
 
 
 
 
 
 
 
Interest-earnings assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
 $                      			1,001 
 $                      			5 
        			2.01 
%
1,226 
16 
        			5.29 
 
 
Federal funds sold
                         			5,020 
                       			37 
        			2.96 
 
16,235 
208 
        			5.20 
 
 
FHLB stock
                         			3,340 
                 			      57 
        			6.86 
 
2,595 
37 
        			5.78 
 
 
Investment securities available for			sale, nontaxable (1)
                       			52,571 
                     			459 
        			3.51 
 
47,757 
424 
        			3.60 
 
 
Investment securities available for			sale, taxable (1)
                       			49,633 
                     			631 
        			5.11 
 
65,686 
747 
        			4.61 
 
 
Loans, net of unearned (2)
                  			1,068,983 
                			19,051 
        			7.17 
 
951,523 
18,766 
        			8.00 
 
 
 
Total interest-earning assets
                  			1,180,548 
                			20,240 
        			6.90 
 
1,085,022 
20,198 
        			7.55 
 
 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
                       			33,388 
 
 
 
31,605 
 
 
 
 
Allowance for loan losses
                        			(7,434)
 
 
 
(8,427)
 
 
 
 
Premises and equipment, net
                       			25,568 
 
 
 
24,867 
 
 
 
 
Goodwill
                         			3,688 
 
 
 
3,688 
 
 
 
 
Core deposit intangibles
           			                   74 
 
 
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